With stocks at a five-year high, corporate earnings season could bring an awaited inflection point if CEOs sound sour on the future.
Dozens of corporate earnings reports are expected in the week ahead, including J.P. Morgan, Citigroup, General Electric and Intel. While always important, the attitude of companies seems to be even more key this quarter, and their assessment of future business prospects could provide an important tell about the course of not just the U.S., but the global economy this year.
That is, in part, because it was U.S. companies that put the brakes on spending, as they awaited the year end outcome of the congressional debate over the "fiscal cliff." It was also because they felt the chill in 2012 from a slower China and a weak Europe.
But the view coming into 2013 is that things are changing, and there is guarded optimism that China may be beginning to turn and that Europe is stabilizing. Housing is helping the U.S. economy, but once again markets and the economy will be vulnerable during the next round of budget debates and debt ceiling showdown in Washington, expected in the next couple of weeks.
"With abating euro-area stress and a lifting China further calming fears, business activity is poised to rebound," wrote J.P. Morgan economists in a note this week. However, they expect the fiscal drag from higher taxes will weigh on U.S. growth, which they expect will be a sluggish 1.2 percent in the first half and 2.8 percent in the second half.
Stock strategists generally expect the market to respond to a better economic tone in the second half, after the next drama in Washington passes, and as the U.S. economy, and corporate earnings pick up again. So if corporate America doesn't share that view when fourth-quarter earnings are released,the stock market will quickly take notice.
"I think corporate commentary this quarter is incredibly important in a going forward basis. The sentiment is definitely more bullish.Even if you look at investor flows all the equity flows in December went into international funds, " said Gina Martin Adams, institutional equity strategist at Wells Fargo Securities. "Even the retail investor is putting money into the China recovery right now. The market seems to reflect a much better optimism. Now it's up to companies to confirm what markets expect."
In the first days of January, investors (and their 401(k)s) found a new love for stocks, and over $22 billion went into long-term equity mutual funds and exchange-traded funds, in the week ended Jan. 9, according to Bank of America Merrill Lynch. That was the second-highest amount on record after the $22.8 billion that went into all equity funds in September of 2007,the month before the Dow and S&P reached all-time highs.
Thomas Lee, J.P. Morgan's U.S. equity strategist, said he thinks it will be a better-than-expected earnings period, with profit growth of about six percent, more than double consensus expectations. He also thinks company comments will be important, and he expects them to be positive. Lee believes earnings have troughed, unlike Adams, who expects another two wobbly quarters.
"I think visibility today is better than it was a quarter ago and two quarters ago," he said, adding CEOs were more concerned about the potential impact of the fiscal cliff on taxes than they are about the spending battle brewing in Washington. On New Year's Day, Congress voted to allow the 2-percent payroll tax cut to expire, a tax that affects all American workers. Tax rates for the top 1 percent reverted to higher Bush era levels,and capital gains and dividend taxes rose to 20 percent from 15 percent. There was also a limit on some deductions.
"I think earnings are going to accelerate ... I think the market will do well in earnings season, but I think the problem will come when people are too bullish. I don't think we're there yet," he said.
Adams said investors are still negative about the market. "We've had an absolutely magnificent earnings recovery and a very strong price recovery. Yet the sentiment is still relatively dim," she said.
"We're not even four years from our trough and we're retesting our highs. That's almost unheard of."
Lee said another plus for the stocks is that record low borrowing costs are helping boost corporate attitudes. Just this week, companies issued a record $44.1 billion in investment grade debt, according to Thomson Reuters.
"That's going to give CFOs more confidence as well because they will feel like they have a lot of financial flexibility," Lee said.
Companies also look set to test the IPO market in the week ahead. While January is normally the slowest month for initial public offerings, with an average half dozen deals, there are five possible candidates to go public next week. They include Cyrus One; Norwegian Cruise Line; USA Compression Partners: CVR Refining and Suncoke Energy.
Besides earnings, there are quite a few Fed speakers,including the chairman himself, who speaks on the economy and takes questions at the University of Michigan after the market close Monday. The markets are looking to the remarks of Ben Bernanke and several other Fed speakers in the coming week to give more context to the comments in the minutes from the Fed's last meeting. In those minutes, several unnamed Fed officials favored ending quantitative easing this year. That sent interest rates higher, and the Treasury market continues to debate whether the Fed could end its asset-purchase program earlier than expected.
"This is his first appearance in a while. He might be helpful because there's a view that the Fed has become a bit more hawkish. He might come out as more balanced. I think it's going to be helpful actually,"Lee said.
Stocks closed out the past week with a gain, with the Dow up 0.4 percent at 13,488. The S&P 500, also up 0.4 percent, is at its highest closing level since December 2007, and the Nasdaq was up 0.8 percent at 3125.The 10-year yield, off its highs, was at 1.86 percent at the end of Friday.
What to Watch
Economic data in the coming week includes some of the first looks at January activity — in the Empire State survey Tuesday and the Philadelphia Fed survey Thursday. There are also inflation data, with PPI Tuesday and CPI Wednesday. Retail sales will also be important, with the December report released Tuesday.
China also has some important data releases. On Friday, it releases GDP, retail sales and industrial production. Better-than-expected export data this past week drove stocks and commodities higher globally.
Barclays analysts expect to see 7.8 percent GDP growth for the fourth quarter.
"We maintain our slightly below-consensus 2013 growth forecast of 7.9 percent. Our baseline projections look for 8 percent export growth, assuming a stabilizing US economy, robust emerging markets recovery,and improving Chinese demand," the Barclays analysts wrote in a note.
"We remain cautious about China's growth recovery in 2013,despite upside surprises in December exports and a jump in total social financing," they noted.
"China is clearly coming back, and I would not be surprised if you see GDP growth above 8 percent," Alcoa CEO Klaus Kleinfeld said on"Closing Bell" after the company reported earnings.
Adams said it's too soon for any improvement in China to show up in corporate earnings, but it will be important to hear if other companies confirm Alcoa's sentiment.
"I have underweights on materials and industrials right now because the earnings streams have been so awful, and the revisions momentum has been negative. The fact you saw Shanghai and the Hang Seng (indices) break out in the fourth quarter could be an indication you're going to see a turn in those sectors," Adams said."Usually, the commodities markets are pretty well in tune with what's going on in emerging markets particularly in China and copper prices have traded closely with what's going on in China. I'd like to see a break out in copper. We're counting on some kind of recovery in China to take hold this year."
Earnings: PPG Industries
1155 am San Francisco Fed President John Williams
1240 am Atlanta Fed President Dennis Lockhart
0400 pm Fed Chairman Ben Bernanke discusses economy/policy at University of Michigan
Earnings: Burberry, Forest Labs, Lennar, Commerce Bancshares, Linear Technologies
0800 am Boston Fed President Eric Rosengren
0830 am Retail sales
0830 am PPI
0830 am Empire State survey
0850 am Minneapolis Fed President Narayana Kocherlakota
1000 am Business inventories
1230 pm Philadelphia Fed President Charles Plosser
0700 am Mortgage applications
0830 am CPI
0900 am Treasury international capital flow data
0915 am Industrial production
1000 am NAHB home builders sentiment survey
1000 am Kocherlakota speaks on policy
0200 pm Beige book
0630 pm Dallas Fed President Richard Fisher
0800 pm Kocherlakota speaks on policy
0830 am Initial claims
0830 am Housing starts
1000 am Philadelphia Fed
1205 pm Lockhart
0955 am Consumer sentiment