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Market Insider: Good Earnings Could Counter October Fears

Wall Street will quickly shift its focus to corporate earnings news once the books are closed on the third quarter this week.

Wall Street traders
CNBC.com
Wall Street traders

Joe Quinlan, for one, thinks investors are in for some good news. "I'm encouraged that there's a skepticism about the earnings potential for third quarter. A lot of investors are underestimating how productive U.S. companies have become," said Quinlan, who is the chief market strategist at Bank of America Merrill Lynch. "I think final demand is picking up."

Third quarter earnings for the S&P 500 companies are expected to be down 24.7 percent. Many analysts think the bar is higher than last quarter in terms of upside surprises. The quarter wraps up Wednesday, and the earrings reporting season starts with Dow component Alcoa on Oct. 7.

Of the S&P 500 companies, 73 percent saw positive earnings surprises in the second quarter, and the street has been raising estimates ever since. Quinlan said he is in the process of ratcheting up his own estimates for the third quarter. He also expects to hear more encouraging comments on the outlook from corporate managements as they release earnings news.

Stocks were boosted by a spurt of merger and acquisition activity Monday. Xerox said its buying Affiliated Computer Servicesfor $6.4 billion, and Abbot Labs is buying Solvay's Drug unit for $6.6 billion. About $60 billion in deals have been announced in the last five weeks. Reuters Thomson said there have been nearly $500 billion in deals since the start of the year, but that's down about 40 percent from last year and down more than 50 percent from the 2007 peak of $1.28 trillion.

The return of deal making, however, is a big positive. "It's a sign of business confidence coming back to the market," said Quinlan.

The Dow finished up 124, at 9789, and the S&P 500 jumped 18 to 1962, the best day for stocks since Aug. 21. At the same time, the dollar was firm against a basket of currencies. Oil finished 1.2 percent higher at $66.84 per barrel, while grains and metals were mixed.

Treasuries saw buying on light volume, which drove yields lower. The 10-year was at 3.285 percent, and the two-year was at 0.968 percent. "People are beginning to realize with the twos (2-year note) anchored at about one percent, and the curve breaking above that, a flatter curve is going to be a bull flattening and long rates have to fall," said William O'Donnell, head of Treasury strategy at RBS.

"It took a long time, but people are buying into this whole thing.. as households and banks repair balance sheets, it's leading to a higher savings rate, weaker growth and a lower inflation outlook." O'Donnell said the market was relatively quiet Monday due to the Yom Kippur holiday, the approach of quarter end, and ahead of the Friday jobs report.

Trick or Treat

Just as many investors had expected September to be a terrible months for stocks, there's some trepidation about October, historically a month of volatility and some memorable crashes. "I'm not fearful about October. I think a lot of investment managers are going to put money to work in October to get that performance," Quinlan said.

He said earnings are just one catalyst that will keep stocks positive into the year end. "What I'm telling clients is between now and the end of the year, there's another 5 to 8 percentupside," said Quinlan. He expects the S&P 500 to finish the year somewhere around 1150.

There are other strategists, who believe a pull back is on the horizon and the timing could be October because of earnings reports. Quinlan disagrees. "It could be we start out of the gate with some weak earnings announcements," he said. But he thinks the overall picture from the reports will be that the worst is over and that will help the market.

"I've been surprised in particular by the resiliency of the global economy...the rebound, the synchronized global expansion. It's not just the U.S.," Quinlan said.

"Where we are in the global economy, I thought we'd be first quarter of next year," he said. Another factor that will keep money moving into stocks is the unwillingness of Central Banks to raise rates for awhile.

There is also a large amount of money, sitting in money market funds that could still be invested in stocks. "There's $3.5 trillion U.S. dollars in investor cash sitting on the sidelines," he said.

Quinlan is bullish for now, but he says the market could run into trouble early next year when the resiliency of the recovery is tested. Issues such as cap and trade, health care reform, the growing U.S. budget deficit and unemployment could all worry the market. "You don't want to be cute in terms of trying to time. We're investors, not traders, but we do think there's good momentum upside from now until early next year," he said.

U.S. stocks could also benefit from a rotation away from emerging markets as investors take profits from big moves there and redirect them into relatively cheaper U.S. big cap names.

What to Watch Tuesday

  • Tuesday's market will be watching the S&P/Cash Shiller Home Price Index at 9 a.m.
  • Consumer confidence for September at 10 a.m.
  • There are a few earnings, including drug retailer Walgreen before the bell, and consumer sensitive companies, Darden and Nike , after the bell.
  • The FDIC meets to discussing funding, among other topics. News reports on Monday said the FDIC is expected to collect banks' regular premiums early in order to pump up the waning deposit insurance fund.
  • The Senate banking committee holds a hearing on bank supervision, and the Securities and Exchange Commission holds the first of two days of meetings on short selling.
  • The Senate Finance committee is back to work on the healthcare bill.

Memories

If you're anxious about the stock market erasing some of its recently won gains, think back a year ago. The Dow finished Sept 28, 2008 at 11,143, and after the House vote on the bank bailout package failed, it finished Sept. 29 down 778 points at 10,365, still above where it is today.

— Questions? Comments? marketinsider@cnbc.com

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