As earnings take over, fundamentals to be tested
This week marks the first big week of second-quarter earnings, and it is sure to bring both joy and misery to Wall Street.
Investors will concentrate on market fundamentals after weeks when Federal Reserve policies have dominated the market. If they see companies are still struggling, stocks could take a fall.
Even after Fed Chairman Ben Bernanke scared markets in June by telling investors the Fed is likely to reduce monetary stimulus in coming months, stocks have recovered, with both the Dow and S&P 500 climbing to all-time highs. In an appearance earlier this week, the Fed chairman said monetary policy was likely to be accommodative for some time.
"We're in the terminal stages of a Bernanke-driven bubble," said Walter Zimmerman, technical analyst at United-ICAP in Jersey City, N.J. "While a lot of damage has been done to the bear case, eventually bad news like weak earnings growth will start to bear fruit."
To be sure, the Fed, which has shown a much friendlier face to investors lately, will not be out of the picture. Bernanke will appear before congressional committees on Wednesday and Thursday to deliver the semiannual testimony about monetary policy. However, few surprises are expected.
The S&P's 17.8 percent advance in 2013 is largely attributable to the central bank's accommodative policies. The major indexes made impressive gains in the week: the Dow up 2.1 percent, the S&P 3 percent higher and the Nasdaq up 3.5 percent. It was the third straight week of gains for all three, and the best week for the S&P and Nasdaq since early January.
"The Fed has been able to prevent a big selloff so far, but eventually the economy will have to catch up to the market or the market will fall back to match the economy," said Scott Armiger, who helps oversee $5.6 billion as portfolio manager at Christiana Trust in Greenville, Delaware.
More Focus on Earnings
That analysts are now turning their focus to earnings, believing the Fed's power to buoy stocks is waning, may not be a positive if the rally is going to continue.
Earnings are seen growing 2.8 percent in the second quarter, according to Thomson Reuters data, a far cry from the 8.4 percent growth forecast by analysts on January 1. Revenue is now seen growing 1.5 percent.
For every company that has said it expects positive earnings, 6.5 have lowered their forecasts, the worst positive-to-negative ratio since the first quarter of 2001.
United Parcel Service, the world's largest package delivery company, tumbled on Friday after giving a weak profit outlook, citing economic conditions as one reason.
(Read more: Family Dollar soared after earnings)
Companies can appear to look good when they beat a lowered earnings bar, but signs of weakness will hurt a market that is hovering near all-time highs and seeking new catalysts to spur further gains.
"The second quarter wasn't particularly robust, and estimates seem to still be too high," said Barry Knapp, managing director of equity research at Barclays Capital in New York. "We don't really see any sector where there is a positive risk/reward, just places where there are more likely to be negative surprises."
Next week about 70 S&P 500 companies will report results. If the results indicate that companies' earnings are still weak despite intervention by the world's major central banks, shares could slump.
Financial companies may be the most in view as investors look to reports from Bank of America, Citigroup, Goldman Sachs, and Morgan Stanley, among others. The sector is seen posting profit growth of 19.6 percent in the quarter, by far the highest among S&P groups.
"Since they have the highest growth expectations, it will be especially important for the market that they live up to those expectations," said Sam Stovall, chief investment strategist for Standard & Poor's Equity Research Services in New York. "Those results will be pivotal."
Early results from financial companies were mixed. Wells Fargo and JPMorgan Chase posted profits that beat forecasts, though JPMorgan said it might be forced to accelerate cost-cutting because of difficult market conditions.
Among economic reports, June retail sales will be released on Monday, with consumer prices and housing starts, both for June, will be released later in the week. The July Philadelphia Fed survey of manufacturers is due on Thursday.