Stock market action is choppy and trading volume is low, but this is a stock market that still wants to go up because of the Federal Reserve’s actions and the fair valuations that are still present. We’ve had some decent earnings reports already, and while we’ve had meaningful earnings warnings, this hasn’t dampened investor sentiment. Like in previous quarters, not all companies or industries are experiencing the same level of business conditions. The marketplace knows this and is sticking with existing stock market winners.
Visibility for the fourth quarter will be the catalyst for the stock market this earnings season. Companies don’t need to outperform in the third quarter; they only need to confirm or increase guidance for the fourth and this market will keep going higher. There are still a lot of structural problems with this stock market, and you certainly can’t call it a bull market. But share prices are likely to keep ticking higher over the near term, even in the face of conflicting economic news.
We know that there is continued economic weakness in the eurozone and China’s economy is slowing significantly. Earnings warnings from Intel Corporation (NASDAQ/INTC) and NIKE, Inc. (NYSE/NKE) are a direct result of this. (See “Don’t Get Caught—These Earnings Warnings Mean Something.”) But the trend I’m seeing in corporate earnings so far shows better business conditions in the domestic U.S. market. The problems abroad remain, but the numbers are showing improvement in the U.S. economy, albeit inconsistently.
I think it’s important for investors who want to take on new positions in this market to do so with a focus on companies with large domestic operations. As I’ve written before, investment risk abroad is just too high these days with the sovereign debt crisis in Europe, geopolitical instability in the Middle East, and a lack of consistency in Asian economies. If I were a buyer in this stock market, as a general strategy, I’d stick with large-cap dividend paying stocks that are trading right near their 52-week highs. I think it’s more probable that the stock market’s existing winners will tick higher in price than it is that weaker stocks will turn around. A couple of large-cap momentum stocks in this market include companies like Colgate-Palmolive Company (NYSE/CL) and Abbott Laboratories (NYSE/ABT). You can see their price momentum below:
Chart courtesy of www.StockCharts.com
Chart courtesy of www.StockCharts.com.
This earnings season, companies with major international operations are going to struggle. No amount of cost control can keep earnings afloat with recession in Europe and the policy-induced economic slowdown in China. Going forward, I’m keen to read the earnings results from railroad and industrial companies. As in previous quarters, their results are key to keeping the stock market alive.