Getting The Bad News Out Of The Way

by: David Urban

Last week, the markets felt pressure from a number of areas causing the S&P 500 (SPDR S&P 500 Trust ETF: SPY), Nasdaq (PowerShares QQQ Trust ETF: QQQ), and Dow (SPDR Dow Jones Industrial Average ETF: DIA) to all tumble before a strong rally at the end of the week.

The biggest and most disconcerting news was the collapse of Iowa-based futures broker PFGBest. Over $200 million in customers' money was discovered to be missing from segregated accounts after the CFTC and the NFA gave the company a clean bill of health earlier this year. The fraud apparently went as far back as 2010, leaving many people shocked and dismayed.

The most disconcerting part of this fraud is the CFTC and NFA's inability to properly police their members. A second stinging failure within a year indicates significant vulnerabilities within both organizations. Earnings warnings started to trickle in as companies rushed to get the bad news out ahead of their scheduled announcements blaming weakness in Europe and the overall global economic uncertainty.

The worrisome part of the warnings is that they spanned many sectors of the economy. Big box retailer hhgregg, Inc. (NYSE:HGG), industrial goods manufacturer Cummins Inc. (NYSE:CMI), and technology companies Advanced Micro Devices, Inc. (NASDAQ:AMD) and Applied Materials, Inc. (NASDAQ:AMAT) were all warned as the problems in Europe spilled over into all sectors of the global economy.

In a spot of good news, jobless claims fell to 350,000 in the prior week as automakers put off retooling due to the 4th of July holiday falling in the middle of the week. The trend is expected to reverse itself in coming weeks, so future numbers will be skewed accordingly.

JPMorgan Chase & Co. (NYSE:JPM) and Wells Fargo & Co. (NYSE:WFC) both reported earnings last Friday. JPMorgan stated that losses from the "London hedge" totaled $4.4 billion and revised first-quarter earnings lower by $459 million. In a refreshing statement, Dimon noted that some traders may have hidden losses on their trading books, and that pay has been clawed back from executives responsible for the trading disaster. The bit of honesty was a nice touch after the hubris surrounding his testimony before Congress, although the use of the phrase 'Fortress Balance Sheet' continues to unnerve me.

Wells Fargo's earnings were strong as well, giving hope to the markets that earnings season may not be as bad as expected. With the bad news out of the way, the markets can now focus on the good news from earnings reports, which should support the market for the next few weeks. Earnings reports will begin to flood the market this week, allowing investors to discern areas of strength and weakness.

Investors need to watch the coming earnings releases very close. Not just for who beats, but earnings growth acceleration and deceleration. Just because a company beats on earnings does not mean it is doing well. If earnings growth decelerates investors need to ask themselves if the current weakness will continue through the second half of the year. Slow earnings growth is not a recipe for PE expansion.

There may be some nasty hiccups along the way, but use the coming weeks as a way to pare the weak hands from your portfolio and preserve capital with an eye to possibly buying them back after the coming sell-off.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I am long a S&P 500 ETF while maintaining a short position in a Russell ETF with the S&P position being a short-term trade.