Earnings to help stocks weather rough patch; advisers cautioned

Some strategists suggest taking profits but being ready to get back into the market for year-end rally

Oct 14, 2014 @ 11:00 am

By Jeff Benjamin

In a light trading day on Monday, investors drove stocks sharply lower late in the day after pouncing on the fact that the S&P 500 Index had fallen below its 200-day moving average price.

While that particular indicator is considered significant by some, most market watchers are waiting to see what happens when everyone is back to work following the Columbus Day holiday on Monday.

“Clearly, traders and investors want to see the market above that 200-day price range, but before passing judgment, we may want to wait for full market participation,” said Quincy Krosby, a market strategist at Prudential Financial Inc.

In the near term, Ms. Krosby is optimistic that this week's “earnings parade,” including a batch of reports from technology and financial companies, will help lift the equity markets and inject some positive sentiment into the environment, which has been marked by high levels of bearishness.

“Earnings could be positive for the market this week, especially if the guidance includes comments about demand for products and services being up,” she added. “We need to hear what companies have to say.”

Indeed, early indications Tuesday suggested the environment was improving, with stocks gaining ground for the first time in four days, helped by better-than-expected earnings from Citigroup Inc. and Johnson & Johnson. JPMorgan Chase & Co., the largest U.S. bank, returned to profitability in the third quarter but its earnings missed some estimates, sending that stock lower.

The S&P 500 index was up 5.79 points, or 0.3%, at 1,880. 53 in mid-morning trading in New York.

Part of dissecting the forward guidance that company reports provide will be getting a sense for how the strengthening dollar will impact stocks over the next several months and quarters.

The stronger U.S. dollar boils down to a boost for consumer spending because it drives down the price of gas and other commodities, but it also hurts multinational corporations that rely heavily on exports. The bigger picture of the stronger dollar, however, is that it signals weakness in the global economy.

“Right now the U.S. economy is stronger than most developed economies, and as the Fed exits its bond-buying program and approaches higher interest rates, that favors a stronger dollar,” said Karyn Cavanaugh, senior market strategist at Voya Financial Inc.

A currency's strength is measured against other currencies, and a strong currency is typically only an issue when it starts to spike, as the U.S. dollar has recently.

Since the start of the year, the dollar has gained 8.8% compared with the euro, 3.2% against the British pound, and 2.4% against the yen. And most of those gains have occurred since early summer.

“It's really about the magnitude of the fluctuation,” Ms. Cavanaugh said. “Multinational companies can deal with currency fluctuations, but the fact that it has gone up so fast could be disruptive.”

In terms of earnings and guidance for upcoming quarters, the stronger dollar could work as a handy excuse for weaker reports, according to Ms. Krosby of Prudential.

“Just like companies used the harsh winter weather as an excuse earlier this year, we could see companies start using the stronger dollar as an excuse for weaker earnings,” she said. “Whether that will be accurate or not is another story.”

Back to the immediate issue of the stock market's tipping point, Brad McMillan, chief investment officer at Commonwealth Financial, believes investors and financial advisers should be braced for anything at this point.

“It's a matter of preparing clients, the same way you would prepare for a hurricane warning,” he said. “It doesn't necessarily mean you have to evacuate right now, but you should go out and stock up on some supplies.”

The S&P dipped below its 200-day moving average twice in 2012 without much fallout. But the two previous moves below the moving average, in 2010 and 2011, saw the index fall by more than 15% from its peak.

That is the kind of reality that Mr. McMillan says advisers should be watching for.

“You have to be mentally prepared and you have to be prepared in the portfolio,” he said. “If you have a client looking to take some risk off the table, now might be a good time to do that. And it's also a good time to reach out to clients and let them know that this is what history is telling us.”

In the bigger picture, Mr. McMillan is far from bearish on the U.S. economy and the stock market.

“Some of the factors we're seeing supporting the market include the move toward the normalization of the economy, because when interest rates are moving toward a normal level that is a positive for the stock market,” he said. “There's also a positive correlation between [economic growth] and market valuation levels, which is another positive long-term trend.”

But he is also watching the signals that suggest an increasing aversion to risk by investors, including the growing disconnect between small-cap stocks and large-cap stocks.

“Investors are moving from small-caps to large-caps, and that's about an aversion to risk that drives up large-caps, and that usually causes the need for a correction,” he added.

The state of the 200-day moving average is not the biggest concern to Phil Blancato, president of Ladenburg Thalmann Asset Management.

“I'm more bullish today than I've been at any time in the last six years,” he said. “Other than weakness in the housing market, I can't find a single reason based on fact to not be bullish.”

He attributes much of the recent market volatility to geopolitical unrest, profit taking, and the transition toward higher interest rates.

“I don't understand the negative sentiment; October has been this type of month ever since we've known it,” he added. “I don't think the volatility is prolonged and I think we'll get a great Santa Clause rally toward the end of the year.”

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