Risks to Stocks on the Downside as Earnings Season Begins
While yesterday seemed like a yawner to stock traders, stay awake! Many sectors have had huge moves at the end of the fourth quarter and are continuing to rally into the first quarter.
Consider where the following indexes ended last week:
S&P 500 5-year high
Russell 2000 Historic high
MidCap Index Historic high
Transports 1.5-year high
Airlines 2-year high
Home Builders 4-year high
Of course, bears have argued for some time that the main reason stocks are this high, despite measly 2 percent gross domestic product growth, is because of the U.S. Federal Reserve's involvement. But that is a different debate.
The bad news: With prices at these levels, the risk is now to the downside. The Washington Post thinks the debt ceiling will be hit on Feb. 15, and there are plenty who believe that Moody's will downgrade U.S. debt (joining Standard & Poor's) some time in the first quarter when it becomes obvious there will be no grand bargain.
(Read More: Brace Yourself: Disappointing Earnings Ahead)
And that's just the macro picture. We start earnings season today, and the big debate is: Did earnings trough in the third quarter? It's really a matter of degree.
We are looking at an earnings growth rate of 3.2 percent for the fourth quarter, a tad above the 2.4 percent for the third quarter. Topline growth (revenues) was practically nonexistant for the third quarter at 0.4 percent (!), and is only a bit better at 3.3 percent expectation for the fourth quarter.
To give you an idea of how far off these numbers are from historic norms, S&P Capital IQ tells me that the 10-year average growth rate for revenues was 7 percent.
Bottom line: Earnings growth is very modest for the fourth quarter, and topline is still just above flatlining; the outlook will likely be cautious for the first quarter.
Meantime, complacency is high — shockingly high. The Volatility Index (VIX) is near a six-year low. Some traders are suggesting that it is cheaper to simply buy the S&P 500 near in-the-money calls than it is to buy the stock market directly. You can get the same exposure, with way less risk, by owning options.
1) Alcoa kicks off earnings season today, but I'm not expecting much. Aluminum prices — like most commodity prices — went nowhere in 2012, improving only slightly going into the fourth quarter. Inventories remain high. The dollar was weak in the fourth quarter. Overall sales likely declined in 2012. There's an expectation that aluminum and alumina prices will rebound in 2013.
(Read More: Jim Cramer's 'D'-Lovely Earnings Season Strategy)