Second-quarter earnings season is likely to create a positive backdrop for stocks, at least temporarily.
A handful of industrial, financial, transport and tech companies will set the early tone for the quarter in the coming week. The first Dow component to report is Alcoa, reporting after the market close Monday, along with railroad company CSX. Intel reports Tuesday, and Googleand J.P. Morgan are Thursday. General Electric, Bank of America and Citigroup all release results Friday.
Stocks this past week advanced more than 5 percent, the best performance in a year, in part in anticipation that those earnings will be strong. But it's the market correction that started in late April that has made the focus on this quarter's earnings reports even more intense, as traders look to find signs from corporate America that the economy is not as weak as investors fear. In addition to earnings, there is a string of fresh economic reports, including retail sales and inflation data. The Treasury also plans to auction $69 billion in 3-year and 10-year notes and 30-year bonds next week.
"Even just having companies say they booked good earnings is going to be a positive," said Bill Stone, chief investment strategist at PNC Wealth Management.
"One thing that's kept us much more positive is the fact that corporate cash flows are huge," he said "Cash flow has been extremely strong. It certainly bolsters the case when you look at cash flow yields. Companies are very mindful of their cash flows and have themselves set up very nicely."
Deutsche Bank chief U.S. equities strategist Binky Chadha is also looking for a strong showing this quarter and says the market should benefit. "I think we'll trade basically with a positive bias," he said. "Our view is earnings will surprise. They will beat by 5 to 6 percent. We believe forward guidance, especially for next year is going to be very conservative, and I don't think it will resolve the macro uncertainty. Equities are already cheap. If earnings beat, the pressure is for a move on the upside."
Chadha, however, expects the earnings boost to be temporary and the market's bigger fear about the economy will overtake sentiment again for a bit longer. He said he remains constructive on stocks, but he expects the market to take on a more negative bias in another couple of weeks.
"What we've seen in the last five earnings seasons is the market prices in earnings either in the run up or in the earnings season, and then basically puts back its hedges and the market moves down," he said.
"When the earnings will get priced in remains an open question, but it doesn't basically wait for the end of earnings season to happen. It will take at least a week or two. The story will come out and be relatively clear. Once that becomes clear, we think the macro story will again be important and the market will have a downward bias," Chadha said.
In the past week, the Dow rose 5.1 percent to 10,198. The S&P 500 was up 5.4 percent, or 55 points to 1077, its biggest point and percentage gain since the week ending July 17, 2009. Treasury yields rose, and the 10-year notehad its biggest one week price decline since April. Its yield moved back above the psychological 3 percent level to close out the week at 3.06 percent.
Stone said the move above 3 percent in the 10-year yield is a positive sign for stocks. "It's like the human pulse. You actually want it a little higher. We were close to catatonic. To me, it was more of a fear gauge," he said.
Stone said he doesn't believe the economy will double dip, but it may take awhile for the stock market to find enough evidence. "At the end of the day, we say we're positive. When it kicks in? That's hard," he said.
"If in fact, a double dip isn't coming, valuations I don't think are very challenging," said Stone.
Chadha does expect the data to turn more positive and the job picture to improve. He said the softness is a normal set back in a recovery, which should be resolved by fall. For that reason, he maintains a year-end target of 1375 on the S&P, at the high end of the street range.
"There's improvement on a variety of fronts, but the market has moved from one pot hole to the next pot hole. There's concern about whether the U.S. slowing is going to be a double dip. Corporates are going to remain conservative in their guidance because they're always conservative in their guidance. I don't think they are in a position to resolve the macro uncertainty of 2011," Chadha said.
Chadha sees financials, industrials, tech and consumer discretionary as the sectors most likely to have the greatest earnings momentum and upside, as well as potential for margin beats. Energy and materials are the most vulnerable to missing estimates because of their exposure to the dollar and slowing emerging market growth. He expects the appreciation of the dollar to slice about 0.5 to 1.25 percent from second quarter earnings growth.
Cash-rich corporations, still cautious about hiring, are likely to continue their spending on share buyback programs. Chadha said consumer staples companies have purchased the most stock this year, spending an equivalent of 4.6 percent of their market cap. The second biggest buyback group is consumer discretionary companies, spending about 1.7 percent of market cap.
What to Watch
In addition to retail sales Wednesday, the week's dataincludes international trade and the NFIB small business survey Tuesday. Business inventories and import prices are reported Wednesday, as are the minutes of the Fed's last meeting. Weekly jobless claims, PPI producer inflation data, the Empire State Survey, Philadelphia Fed survey and industrial production are all reported Thursday. CPI consumer price data, Treasury international capital flow data and consumer sentiment are reported Friday.
China reports second-quarter GDP and June activity data in the coming week. J.P. Morgan economists, in a note, say they expect the data to show a loss of momentum and they expect to revise down the second half growth forecast for China, toward a growth rate of 8 percent.
Fed Chairman Ben Bernanke speaks Monday in Washington at a Fed forum on the financing needs of small business. The Senate Banking Committee holds a hearing Thursday on the nomination of San Francisco Fed President Janet Yellen as replacement for Fed Vice Chairman Donald Kohn, who is retiring in September.
Investors are also watching to see what type of progress BPmakes in capping its spewing oil leak in the Gulf of Mexico.
Europe and the eurowill stay in the spotlight ahead of the stress testing of European banks, expected to be made public July 23. The euro gained against the dollar in the past week and was as high as $1.272 Friday.
"Technically, the euro has had a huge rebound. It feels like 1.27/1.28 has been very stiff resistance for it," said Boris Schlossberg of GFT Forex.
Schlossberg said one dynamic shifted for markets in the past week when both Australia and Canada reported better than expected jobs data. Those numbers helped remove some concern about a global double dip recession.
"You still have Asia Pacific being the driver of demand, and the commodities economies are really still benefiting from that, but the unanswered question is whether the U.S. is going to join the party and whether its recovery is going to add to global growth. That's why retail sales data is going to be important," he said. Economists expect June retail salesto show a decline of 0.3 percent, narrower than the 1.2 percent decline for May.
Schlossberg said the foreign exchange market will not focus much energy on the U.S. earnings news. "It only matters if earnings weigh on risk appetite. We're going out of the week not as pessimistic as we came in," he said Friday.
Other companies reporting earningsin the coming week include Shaw Group and Novelluson Monday.Chevronalso provides an update for investors that day. On Tuesday, Yum! Brands, Charles Schwab and Fastenal report. Wednesday's reports include Delta, AMR, Marriott, and Texas Industries. PPG Industrials and Novartis report Thursday, and Gannett reports Friday.
Questions? Comments? Email us at email@example.com