Monday Morning Outlook: What's Working in the Bulls' Favor

The consensus estimate for first-quarter earnings season is extremely low

Apr 20, 2015 at 8:27 AM
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While many pundits mark Alcoa's (AA) April 8 earnings release as the official start to earnings season, this past week was a little more eventful. While the bulk of earnings won't visit us until the end of April, 36 S&P 500 Index (SPX - 2,081.18) companies released their numbers, including most of the major financials. The earnings reports were pretty decent, with the nation's largest bank, JPMorgan Chase (JPM), and the infamous "Vampire squid," Goldman Sachs (GS), leading the way. The same cannot be said for the economic reports. Inflation continues to be muted, retailers are still trying to rebound from weak winter sales, and the housing sector struggled to rebound in March.

Despite the influx of earnings and economic reports, the market pretty much shrugged its shoulders throughout the week. That was until Friday, of course, when volatility hit stocks in a big way. European stocks experienced a big drop ahead of the U.S. market's open on Friday, as some lost hope that Greece will do what is needed to receive bailout funds from its international creditors. In a flight to safety, German 10-year bond yields moved all the way down to 0.05%. China also announced that mutual fund managers could make shares available for short selling, which perhaps added to the risk-off sentiment affecting the market late in the week.

In addition to these overseas concerns, those pesky overhead resistance levels reared their ugly head once again. As Todd Salamone discussed last week, many of the major indexes were trading just above or below major round numbers that have spelled short-term trouble in the recent past. The Nasdaq Composite (COMP - 4,931.81) once again failed to take out the 5,000 level that provided resistance on two separate occasions this year. The Dow Jones Industrial Average (DJIA - 17,826.30) continues to struggle with the 18,000 level, and the SPX was once again met with selling on its attempt to break above 2,100. Of course, all of these details are a complex way of saying the market continues to be stuck in a volatile trading range.

Daily Chart of SPX Since October 2014

As we enter the heart of earnings season, it is important to highlight the sentiment surrounding these reports. The general consensus amongst analysts and market participants is that first-quarter earnings season will not be good. The main reasons seem to be the rough winter and everyone's favorite bad guy of late, that mighty U.S. dollar.

In light of these fears, analysts have dramatically reduced earnings-per-share (EPS) expectations during the past few months. Since Dec. 31, 2014, the consensus estimate for EPS growth has been reduced from positive 4.3% to negative 4.8%. We generally see analysts reduce estimates as earnings season approaches, but this time is different. This is the largest downward revision since the first quarter of 2009.

It's not just the analysts, though. Of the companies that have issued guidance ahead of the quarter, 84% have lowered their estimates. This is well above the five-year average of 68%. Most of the explanations center on the strength of the U.S. dollar and just how much it's hurting business. The takeaway for me is that expectations are very low heading into earnings season. This could create potential upside for a market that has continued to hold up despite these concerns.

Another major theme that I'm continuing to see is that everybody loves European stocks more than U.S. equities. The latest BofA-Merrill Lynch survey of global fund managers for April was just released. This poll gives clues about the exposure of a large amount of funds worldwide. U.S. equity exposure was negative 12% underweight in April, a small increase from negative 19% underweight in March, which was the lowest since January 2008. So, where are all these U.S. equity naysayers parking their money? Well, eurozone exposure jumped to positive 60% overweight in March -- the highest in the survey's history. April's reading is still very high, at positive 46% overweight Europe.

Also, in the first quarter of 2015, there was $97 billion of new exchange-traded fund (ETF) assets. Of those new assets, more than 70% were ETFs with international equity exposure. It is clear that the crowd is chasing quantitative easing (QE) all around the world, hoping for a similar rally in Europe as the U.S. experienced with its QE program. The one big difference is that back in March 2009, there was not a crowd of investors chasing U.S. equities expecting this strong bull market. Given the strong outperformance of U.S. equities, perhaps we could see some money from the overcrowded European trade make its way back over to this side of the pond.

The theme mentioned above is admittedly a longer-term one, but may serve as an important backdrop for short-term investors as we navigate the market on a weekly basis. One theme that is more in tune with this week's outlook is seasonality. Over the past 20 years, April is the best performing month for the SPX, with almost all the gains happening in the second half (from the 15th on).

April SPX Returns in Last 20 Years

So far, this market has bucked the trend, and the SPX is up 1.4%, as of April 14. Taking a look back at history, even when the first half is up more than 1%, the second half still performs well (average return of 1.53%, and is positive 75% of the time). So, historically, the next couple weeks are generally won by the bulls.

SPX Returns in the Second Half of April

This week will be another very busy week for earnings reports. Popular names like IBM (IBM), Under Armour (UA), Verizon Communications (VZ), Yahoo! (YHOO), McDonald's (MCD), and Google (GOOGL) are all on tap to report. On the economic front, it will be a pretty quiet week. On Wednesday, we will get a look at existing home sales for March, as well as crude inventories. On Thursday, we have the weekly jobless claims numbers, and we'll round out the week with durable goods orders on Friday.

After major market indexes were rejected by resistance levels at key round-numbers last week, many indices could be facing potential support on the downside this upcoming week. Technically speaking, declines back to year-to-date (YTD) breakeven or round-number levels have been supportive in 2015.

Given the sentiment backdrop discussed, any pullbacks should prove to be good buying opportunities at this point. U.S. equities have been incredibly resilient in the face of a large amount of negative sentiment in 2015. While volatility will likely remain, expectations are still very low for a market that remains in a strong uptrend and trading near all-time highs. History tells us these types of markets generally resolve themselves to the upside.

Read more:

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