Looking For Direction As Earnings Season Gets Underway

Includes: DIA, QQQ, SPY
by: The Simple Accountant

After closing 2012, and beginning 2013 with a stock market rally, trading greeted earnings season with a sort of directionless churn over the past week. Some of the trends we had seen going into the end of the year began to waver, but others continued, giving a murky picture of the market. Let's see if we can find any clarity in the numbers.

Economy: The last week was a slow one both in terms of significant data releases, as well as major policy statements. One of the most significant was the policy decision by the European Central Bank to hold rates steady in the face of slowing Eurozone economies. The announcement pushed the euro to new near term highs, but there was little corresponding movement in risk assets, in contrast to the common pattern seen in recent years where the euro and risk have been positively correlated.

Corporate earnings were generally positive, with the two blue chips reporting - Alcoa (NYSE:AA) and Wells Fargo (NYSE:WFC) - beating estimates. Both had traded higher ahead of earnings, but pulled back after the releases. Next week we get reports from Apple (NASDAQ:AAPL) and from Dow components 3M (NYSE:MMM), Verizon (NYSE:VZ), McDonald's (NYSE:MCD), Microsoft (NASDAQ:MSFT) and P&G (NYSE:PG). Also reporting are most of the major airlines, several major railroads, and a number of regional banks and industrials. These economically sensitive sectors should give some sense of the health of the recovery.

Stocks: The major U.S. equity indexes were all up fractionally for the week on light volume, as the market continued to digest the New Year rally and look ahead to earnings. The S&P 500 and Russell 2000 both reached new 52 week highs on a daily closing basis, while the Dow Transports continued to rally, reaching new near term highs. Turning to the S&P economic sectors, the health care stocks were the big winners for the week, advancing nearly 2%. It was also a fairly strong week for the materials stocks, and for the recently lagging tech sector - even with Apple shares unable to get going. The laggards were the telecoms, with a loss of nearly 2%, and the utilities, which dropped 1%. Both sectors are notable for their outsized dividend yields compared to the broader market.

Turning to foreign markets, which had recently led global equities higher, we saw more softness than in the U.S. Only four of the twelve single-country indexes we follow managed to record gains for the week. Leading the way was the Russian RTS index, with a gain of 2.6%. The rest of the "BRIC" complex traded lower after a nice run since late November. In the broader indexes, the Morgan Stanley developed markets index gained 1.4%, while the emerging markets index posted a fractional loss.

Even with the loss of momentum, the new highs we are seeing do bode well for the market in the near term, and unless earnings disappoint, my outlook for equities continues to be cautiously positive. With so much attention on Apple, I am particularly anticipating that earnings report. The stock appears to be making a stand in the 520s; positive earnings could push it higher, but a disappointment could send it sharply lower. We don't want to see the shares break $500.

Bonds: Treasury yields pulled back from recent highs, but the longer maturities remain above their near term support levels (previous resistance). Inflation indicators remain benign, but we note that while December import and export prices were slightly negative, they were less negative than November. The data is volatile so we can't read too much into it, but the general outlook is that prices remain relatively stable overall, and with a good deal of idle capacity in many industries, the bond market need not get too excited.

Investment grade corporate bonds, which had been correcting since October, have found a bid since the start of the year, while junk continues to push ever higher. Municipals, which had corrected even more sharply as yields spiked in December, have been recovering almost as sharply. It's still difficult to find much that is attractive in the bond market.

Commodities: WTI Crude pushed nearly up to $95 on the steep drop in the dollar, before ending a week of volatile trading under $94. Natural gas came off support below $3.20. The precious metals also took advantage of dollar weakness, as gold tried to move off its own near term support, but it came back with the continuing contract failing at its 200 day exponential moving average. Copper has been unable to build on its year-end rally, and we saw a bearish engulfing the brought it back to bear term support Friday. To the extent that copper prices do signal economic strength or weakness, we aren't getting much here. The grains appear to be attempting to break a four month downtrend.

Currencies: The dollar index has run into resistance at the 200 day moving average since the start of the year, and pulled back hard after the ECB policy announcement, as the euro broke above $1.33. We saw all of the majors advance against the greenback except yen, which did a small counter-trend bounce early in the week, only to fall to fresh lows. It is now very near to the Japanese policy target of 90 yen to the dollar.

Key Takeaways:

  • Stocks are looking for some direction, and with earning season heating up, we should get some indication of which way the market is headed in the coming week. As always, it is not the earnings themselves that matter as much as the market's reaction.
  • The euro is extended to the upside, and we could see it correct in the coming week. This often coincides with weakness in risk assets, so it bears watching.
  • With the markets looking for direction, and options expiration at the end of the coming week, it makes sense to wait before putting on trading positions. We are on hold as far as new buys or sells for now.

Note on my S&P strategy: I had intended to take a 100% long position Friday after Thursday's new high. However the intraday action kept me on the sidelines, and the strategy is still in cash.

Disclosure: I am long AA, PG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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