Earnings begin next week:
1) Better economic numbers reduce recession fears, and that helps EPS. This week we saw better than expected ISM, ISM Services, September same store sales, and nonfarm payrolls, all of which have reduced the likelihood of a recession. (Read a different perspective: Some See US Near 'Modern-Day Depression')
Recessions are bad for earnings: Dan Greenhaus and others have noted that earnings fall by about 20 percent in an average recession. Bottom line: most strategists have earnings of $95 to $98 for 2011 S&P 500 earnings; despite some trimming, those numbers have not dropped dramatically.
There was a near-panic in the beginning of August as economic data weakened further, and many predicted that 2011 numbers would end well below those estimates. We'll see, but recent data reduces that likelihood.
2) Earnings start, as always, with Alcoa: don't expect much. Alcoa's earnings have always depended on two things: 1) the price of aluminum, and 2) their ability to control costs. Aluminum prices have been dropping all quarter, and there have been indications that costs containue to go up, so expect pressure on margins.
3) What about all this wild volatility? Oddly, it may help earnings. Goldman Sachs, in a recent note, observed that when volatility was high (when the VIX was between 35 and 45, where it is now), stocks rose 60 percent of the time on their earnings reports for an average return of 2.9 percent (outperformance of 1.7 percent vs. the S&P 500). This suggests an obvious strategy: buy calls ahead of earnings reports, which Goldman notes produced a 37 percent return on premium.
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