Now that a brutal Q3 for stocks has finally come to a close, it is worthwhile to turn our attention to the key issues to watch for in the coming quarter. All in all, it promises to be another eventful three months for stocks and investment markets.
The following are four critical events to monitor for stocks as we move through Q4.
Potential Mass Liquidation in Stocks to Kick Off the New Quarter
We were in a similar situation not to long ago heading into the fourth quarter of 2008. Following the collapse of Lehman Brothers on the weekend of September 13-14, a variety of indicators were signaling that stocks should be selling off. But they managed to hold their ground through the end of September, only declining by -3% on the S&P 500 Index during the period from September 15 to September 30 that included an even split of six up days and six down days. But then the calendar flipped and a new quarter started on October 1. And over the next eight trading days through October 10, stocks cratered by -28%.
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Fast forwarding to 2011, stocks have been trading sideways since bottoming on August 8. But during this same period, a variety of key indictors supportive of stocks have deteriorated considerably. This includes Greek and Italian bond yields, European and U.S. financial share prices, Preferred Stock and High Yield Bond prices, and global stock prices outside of the U.S. While another -28% decline is not likely, the potential for a sharp and sustained U.S. stock sell off is high now that we are past any quarter end positioning and a new quarter is now underway.
Earnings Season
The most common refrain from those still bullish on U.S. stocks is the persistent strength of corporate earnings. But the notion that strong earnings growth and peak profit margins can be maintained during a period of global economic weakening and potential recession in the U.S. and Europe is a challenging argument to sustain. This idea will be put to the test starting over the next few weeks as the third quarter earnings season gets underway. Of course, if corporate earnings and forecasts come in at or ahead of expectations, this should provide some much needed relief to the reeling stock market. However, if companies disappoint on earnings and/or revise forecasts lower for the coming quarters, this would unravel the strong earnings thesis and put added downside pressure on stocks. Moreover, if the U.S. economy were to descend into recession, this would also imply a lower price-to-earnings ratio multiple for stocks, which would further fuel any moves to the downside.
If Friday’s lowered forecast from industrial manufacturer Ingersoll Rand (IR) is any indication, it could be shaping up to be a difficult stretch on the earnings front in the weeks ahead. Alcoa (AA) kicks everything off on Tuesday, October 11.
Greek Default
This is the catalyst event that the market seems to be anticipating. And with the probability of default currently running at well over 90%, these expectations are justified.
While the market may react severely immediately following any news of a Greek default, it is also possible that the initial market response may be muted. After all, U.S. stocks traded sideways for two weeks after the collapse of Lehman Brothers. And European leaders may even be able to effectively respond to the crisis by stemming the damage and providing sufficient capital to adequately support at risk financial institutions. Thus, the potential exists for Greece to liken itself to Bear Stearns instead of Lehman.
But the other important key is what other European debt markets would come under pressure. For if Greece ends up being Bear Stearns, Italy could just easily end up being Lehman (or worse) before its all said and done.
With the European sovereign debt crisis far from resolved, this will continue to be a critical situation to watch closely in the coming quarter.
The Fed Wild Card
To the dismay of staunch stock market bears, the U.S. Federal Reserve remains a key wild card. At any moment depending on how events unfold, they may decide that its time to step beyond Operation Twist and go all in for another round of full blown QE3 stimulus. Of course, the stock market would likely surge with intoxicated delight at such news, at least initially.
The key question becomes whether any QE3 program would lead to the same seemingly endless stock melt up in defiance of any sustained economic support that accompanied QE1 and QE2. Toward the end of QE2 starting in March 2011, stocks for the first time stopped responding positively to the steadily expanding Fed’s balance sheet. Thus, it is possible that stocks, after over two years of receiving a virtually uninterrupted stream of monetary adrenaline had finally grown immune to its effects.
If this is truly the case and stocks were to fail to respond positively to a QE3 program implemented by the Fed, this would be a very bearish development for stocks, as a key source of “hope” for stocks would be essentially eliminated.
Bottom Line
The coming quarter has the potential to be even more eventful than the last. And the potential exists for downside shocks right from the outset. And the four critical events discussed in this article are just a few of the many themes worth monitoring closely as we move through the quarter. It should all be very interesting to see.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
