David Kelly: The next three weeks are telling for the markets

David Kelly is the chief market strategist at JPMorgan Funds. The following is his market commentary for the week of Oct. 18. The next three weeks could set the tone for financial markets for the rest of the year. This week, 113 of the S&P500 companies will report their earnings, including industry bellweathers such as IBM, Caterpillar, Johnson & Johnson, Bank of America, Verizon and Boeing. So far this earnings season, about 70% of firms have surprised to the upside compared with 23% falling short. A continuation of this trend could push the aggregate estimate of S&P500 third quarter operating earnings above the $20.90 seen in the second quarter. Economic data due out this week will largely fill in the gaps on estimates of third-quarter GDP which is due out on October 29th. Monday's Industrial Production report could show a small gain despite a weather-related falloff in utility output. Housing Starts, due out on Tuesday, seem set to fall back from already extraordinarily low levels. Unemployment Claims, on Thursday, may garner the most attention, as analysts speculate on whether last week's unexpected jump was a fluke in an otherwise slow downtrend. At this stage, it appears that real GDP grew at a roughly 2% to 3% rate in the third quarter, and it is unlikely that analysts will adjust these forecasts much on the basis of this week's readings. A number of Federal Reserve officials will be speaking at various venues this week. However, it is unlikely that they will shed more light on the type and degree of the quantitative easing that is expected from the FOMC's Nov. 2/3 meeting given Ben Bernanke's reticence on the issue in a speech on Friday. The political temperature is also rising as we approach the mid-term elections. Current polling suggests that the Republicans may take the House and fall short of taking the Senate. However, for markets, an even more important issue will be the posturing of the parties concerning the extension of the Bush tax cuts. A worst-case scenario for markets would be a standoff which allows all of the tax cuts expire, so analysts will be nervously watching the political tea leaves to try to handicap this danger. Overall, despite a flood of earnings reports, it may be a “wait-and-see” week. However, with stocks looking very cheap relative to high-quality corporate bonds while investor money continues to flow the other way, there is no guarantee that a week without resolution on major issues will be one without major moves in markets. This makes a disciplined and balanced approach just as important today as in the weeks ahead despite their potentially bigger headlines. ***** ***** *****