Why Stocks Are Off Their Highs

Stocks are off their highs on several issues:

1) Hawkish comments from Dallas Fed's Fisher critical of QE2 and implying there was no way he would support QE3;

2) The Catch-22 with QE3 is now obvious to all: Bernanke has said the bar would be set high, that signs of deflation would be one of the primary reasons for doing QE3 again ... but every time we get a QE3 "risk on" rally with commodities up, it (by definition!) makes it less likely that QE3 will happen.

3) Concerns on earnings commentary. Forget QE3 or the debt ceiling...my main concern for the stock market in July is earnings. Banks begin reporting tomorrow. Traders have looked at the downbeat semiconductor commentary this week from ASML, Applied Materials , Novellus, and Microchip Tech , all of which have talked about a more cautious outlook ... in the second half of the year.

This is not the way it was supposed to be. It's not just Bernanke who was anticipating the "soft patch" would be transient. The analyst community is expecting earnings to increase for Q3 and even more into Q4 ... but that's not what we are hearing early on.

Bank earnings will be the next focus—JP Morgan tomorrow, Citigroup Friday. The news will be mixed, but it's now increasingly likely that banks CEOs will emphasize the soft economy and poor loan growth.

There is certainly some good news for banks this quarter:

1) Low expectations

2) Low valuations: many are trading below tangible book value

3) Improvement in regulatory environment

4) And most importantly continuing improvement in credit: expect more banks to release reserves.

The bad news:

1) Weak job growth means weak loan growth

2) Trading weak

All this translates into poor topline growth. In this environment, it would make perfect sense for a CEO to emphasize caution, then suprise later in the quarter on the upside.

One canary in the coal mine on trading profits: Investment Technology Group (ITG), which runs the Posit dark pool (among other trading businesses) is down 14 percent today, as they said results would be weak because of low trading volumes ... they are laying off employees.

Remember we also we will get European bank stress tests on Friday—91 banks. A small German bank—Helaba—has already pulled out of the stress tests—to avoid public failure, according to the FT. Apparently there is a dispute about what instruments should count as top-quality capital.


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