After a terrible week for stocks, bulls are looking for earnings to come to the rescue.
The lost 3.1 percent in the prior week, for its worst week since May 2012. Notably, the week wasn't all red, with stocks interrupting their drumbeat of down days to enjoy the best day of the year on Wednesday. But traders sent the S&P to its close in months on Friday.
More stomach-churning sessions may be ahead as earnings season starts in earnest this week, with giants like JPMorgan Chase, Google, and General Electric (among many, many others) set to unveil their third-quarter results. The big question is whether the spate of earnings will staunch the selling.
"I think the bar is quite high for people to start to get comfortable," said Thomas Lee, managing partner at Fundstrat Global Advisors. Noting the bevy of issues around the world—which range from hard questions about Europe, to the Ebola virus, to the Federal Reserve ending its quantitative easing program—the generally bullish Lee acknowledged that "there's a huge list of worries here."
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The concern underscoring all of these smaller issues has been valuation. As Nicholas Colas of ConvergEx wrote in a Friday note, "Against measures of long-term earnings power, the S&P 500 is clearly expensive at 25 (times) trailing 10-year earnings. When compared to current earnings power of about $120, the multiple is 16x.
While that might be reasonable in an environment of stronger global growth, "it is, perhaps, not a multiple appropriate for a sloppy expansion in the U.S. and threats of deflation and recession elsewhere," Colas said.
However, Lee said none of the recent headlines cause him to second-guess his conviction that the U.S. economy will stay strong.
"When people get concerned about valuation, it's because they're insecure about the length of this business cycle. The valuation concerns really speak to how many investors believe that this rally is all because of central bank actions. But earning are only going to peak when this business cycle peaks," Lee said. The investor added that the upcoming corporate earnings should reassure investors that this hasn't happened just yet.
"Investors are going to look back and realize that this was one of the better chances for them to really step in," he concluded.
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Initial earnings reports have been impressive, with 70 percent of companies beating earnings estimates, according to FactSet. And while the S&P 500's price compared to earnings expectations is nearly 50 percent above the low levels exhibited in the summer of 2011, valuations have fallen significantly below the July peak.
Overall expectations for the upcoming earnings season are about in line with those for recent quarters, with analysts expecting 4.5 percent earnings growth, according to FactSet senior earnings analyst John Butters.
"That probably picks up 2 to 3 percent, so we'll end up in the 7 percent range assuming we see the normal number of surprises," Butters said.
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And whether earnings impress or disappoint, traders are salivating over the prospect that earnings reports will lead to more outsized moves.
"I think there's going to be a lot of opportunity as we see a diverse cross-section of earnings next week," predicted Jeff Kilburg of KKM Financial. "Pick your spots, because it's going to be volatile all week."
But ultimately Kilburg, like Lee, is bullish.
"I want to buy some type of panic on Monday," he said on Friday after the market closed.
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