Stock market trading action has improved over the last few days, even though the S&P 500 Index is about 30 points below its recent post-correction high. The action continues to be reactionary to the daily flow of economic news. Naturally, investors have nothing else to trade on in the absence of an earnings season. I think second-quarter earnings season is going to be fairly good, just like the last five quarters. How the stock market reacts this earnings season will be another story. I don’t think the stock market will mind if big-cap companies miss the consensus estimate; what the stock market wants to hear is decent corporate visibility for the bottom half of the year.
By this time, most corporations will be able to predict with relative accuracy how the last two quarters of the year will turn out, and that’s why institutional investors pay particular attention to the second-quarter earnings season. If corporate visibility comes in below current consensus, then I think the stock market will be in real trouble. Large corporations have excelled during the latest economic slowdown by tightly controlling costs to keep earnings afloat. In the last two earnings seasons, many companies in differing industries said they were able to increase their selling prices without affecting demand, and this is a very important trend that I hope still stands.
Stock market trading action and investor sentiment were not good during the bottom half of last year. And corporations announced very reasonable earnings. What changed investor sentiment on a dime at the beginning of this year was the Federal Reserve, which basically said that it stood ready to assist the economy further if needed. This overture by the central bank was immediately embraced by the stock market, and this is why I’m predicting some additional form of monetary stimulus over the next two quarters.
If the second- or third-quarter earnings season reveals that business is really slowing down, then the stock market will negatively react, and the Federal Reserve will be primed to help. It doesn’t mean that quantitative easing for the third time (QE3) or further increases to the money supply are the correct policy actions to take for the long run, but it does work to boost the stock market over the short term.
I’m very much looking forward to this upcoming earnings season, and my best guess is that it will mostly turn out okay. We should see some weakness in the retail sector, and what the financial and technology industries report will be crucial. The industrial economy is the most likely to continue with its positive economic trends, and lower oil prices should be visible in the reporting. (See “How Are You Going to Earn in the Age of Austerity?”) The stock market is currently fairly valued given all the information. One thing this second-quarter earnings season will do is reset expectations, for better or worse.