Last week markets remained within their tight trading ranges of the past month, the only difference being that they pulled back towards the lower end of that range, as exemplified by the bellwether S&P 500's over 2% drop.
While it's possible that last week's drop was just another gyration within that trading range, here are reasons we believe that next week is more likely to bring a more extended pullback.
1. Q3 EARNINGS SEASON: CATALYST FOR A PULLBACK?
As noted in our review of last week's top market movers, "Prior Week Market Movers: Q3 Earnings, Data, Overcoming Central Bank Manipulation?", the big take-away lesson was that a poor Q3 earnings season may be what ends the prevailing notion that risk assets can continue to rise despite:
- Global growth slowing
- An increasingly poorer Western consumer that has been the foundation of both developed world and BRIC export economies
- Potentially catastrophic threats to the largest consumer economies from the EU solvency crisis and US fiscal cliff
Of course, all of the above have been with us for some time and markets have still either continued higher or held their ground. The only big change last week was that Q3 earnings season began, and thus far indeed looks like it may be the worst in years. Until last week, bulls waved off these concerns by saying that the weaker season was already anticipated and hence priced in.
Last week' ~2% drop in US indices suggests that's not the case. However the first week of earnings season is relatively light.
Earnings season is most influential on markets in its second and third week.
This second week is the first 'big' week for earnings season, with hundreds of firms reporting and a huge chunk of the big names that tend to get attention and move markets, as detailed in the above mentioned post. If these announcements continue the downbeat tone of last week, and markets continue to pull back without the help of major bearish news elsewhere, then Q3 earnings may prove to be the final evidence that the disconnect between rising asset prices and deteriorating economic fundamentals may be over, regardless of the current money printing from the Fed, ECB, BoJ, PBoC, etc.
Note that we must watch more next week than just bottom line earning beats or misses. Markets will also be watching:
- Future guidance for Q4 2012 and beyond: Some, like Citi's Jason Shoup, feel these are still too optimistic, thus leaving us vulnerable to downward revisions
- Top line revenues: As costs have already been pared, sales growth will be key to growing future earnings.
2-5. EU EVENTS
The EU has remained relatively quiet for weeks as an actual market mover (though it continues to produce headlines and drama). However there are simply too many sources of market crises for that to continue. In the past weeks we've repeatedly reminded readers of reports that Washington wants quiet on the EU crisis front until after the elections, and it appears that the EU is doing its utmost to comply, despite:
Greece is seeking additional cash that by all logic it doesn't deserve because it has shown few signs of good faith in meeting its bailout agreements, and even fewer signs that it might actually repay its current debts, never mind additional ones. Greece will run out of cash within the month without another handout.
Spain showing every sign that it's going the same way as Greece (ongoing bank runs, political instability, budgets based on unrealistically optimistic growth projections, etc)
2. EU Summit
Per the recent European Finance Ministers meeting, Greece may well get its cash anyway, be it due to Washington's request for quiet or simply the belief that the resulting contagion risk is too high and would cost far more than the 'loan'/handout to Greece. Few expect any meaningful action on Spain, which is avoiding any moves on a bailout until after October 21 regional elections, and in general is trying to avoid a bailout with conditions that would prove politically unpopular, like tax increases, spending cuts, or other steps needed for repaying its debts in a timely manner.
3-4. French, Spain Bond Auctions, Other Events
Spain has a key auction of benchmark 10 year bonds, and France also has a bond sale this week. Thus the ECB typically makes sure all looks well, so any problem with spiking yields or weak demand can make markets nervous.
In addition to Spain's bond auction, Spain also has regional elections in Catalonia and Galicia, and there's the threat of a credit ratings review from Moody's that could push Spanish bonds into the junk category. Last week's downgrade was seen as bullish, because supposedly it moved Spain closer to a bailout. However, that assumes Spain will submit to EU conditions before doubts of its solvency bring yet another market crisis. We suspect that a market scare is more likely than a smooth transition to bailout, particularly once US elections have passed.
France also has a bond sale this week. France has remained off the radar thus far, but few expect it to remain so. One bad auction is all it takes to get markets focused on France's worrisome data and puzzling policies to improve its debt and growth situation.
5. UK Events
In addition to UK inflation, jobs, and consumer spending data, the big UK event this week is the BoE meeting minutes release, because it could show if the BoE is moving closer to following the Fed, ECB, BoJ, PBoC, and others into easing.
6. US RETAIL SALES
In addition to Q3 earnings, the big event for the US will be retail sales, which will either confirm the latest improved jobs figures or refute them. In the end, the significance of improving jobs is improving spending, given that US GDP (and thus job growth) depends mostly on improving consumer spending.
7-8. CHINA, AUSTRALIA DATA, SIGNS OF MORE EASING
There's a batch of data due from China, including September trade balance numbers, consumer and producer prices, industrial production, retail sales, and 3Q GDP. If these worsen, markets could either react negatively, or, as is happening more frequently in these times of stimulus being the last hope for bulls, positively if the data is bad enough to raise hopes for more stimulus. Recent comments from PBoC Governor Zhou have fed hopes that more easing is coming, and that's kept Chinese markets in relatively good shape, and also supported the AUD, given the close link between Aussie and Chinese GDP.
The RBA will release its latest meeting minutes, and these too could move markets if they yield hints about whether more easing is coming or not.
9. TECHNICAL WEAKNESS COULD BECOME SELF-FULFILLING
Many have noted that the S&P 500 is dangerously close to its 50-day moving average, risking a cross below it (aka an 'iron cross or 'death cross') that sends a strong technical signal of further downside ahead. In the absence of positive news, such widely followed technical signals can become self-fulfilling prophecies.
10. OTHER CALENDAR EVENTS
Other top calendar events not mentioned above include the following:
- Tuesday: German ZEW economic sentiment
- Thursday: US Philly Fed Mfg Index
- Friday: US Existing Home Sales
See any good economic calendar for further details
PARTING THOUGHTS: OBVIOUS PROTECTION IN UNCERTAIN TIMES
While the coming week could play out in a number of ways, what is virtually certain in the longer term is that the leading central banks remain committed to printing money, even if their currencies fall and drag down the value of anything denominated in them.
That means if you're based in USD, EUR, JPY and other currencies subject to central banks in easing mode, you need to start increasing your exposure to more responsibly managed currencies or assets linked to them.
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.