Q2 Earnings to Disappoint

Investor’s first read – Daily edge before the open
DJIA: 17,949
S&P 500: 2,102
Nasdaq Comp.:4,862
Russell 2000: 1,156
Tuesday, July 5, 2016 8:45 a.m.
Soooo, the Street has concluded the Brits’ vote to exit the EU will have no impact on global economies. What else is one to conclude with the DJIA and S&P 500 recouping just about all of the Brexit news 5.8% loss.
But, what if Brexit leads to rumors of Frexit, Swexit, Itexit, Denexit, etc. ?
The Fed has made it clear – at the most, it will increase interest rates once between now and 2018. (Yellen’s “new normal”).
This policy and Brexit’s flight to safety has depressed the 10-year U.S. Treasury yield yields 1.39%. Last week, that bond yield hit an all-time low (high for the bond’s price).
Buying bonds under these conditions carries a huge risk, knowing how fickle the Fed has been. One reference to rate hikes by one of its Governors out on the speakers’ circuit and whoosh down goes the price of long-term bonds.
This policy has left money managers little choice but to buy blue chip stocks yielding yields north of 2%.
While a lot of last week’s 4-day rebound was short covering and institutions scrambling to buy targeted stocks in time for the Q2 June 30 reporting deadline, a good portion had to be institutions chasing stocks with attractive yields.
We can expect this pattern to continue extending the market averages higher.
The markets have now recouped most of the Brexit loss, a two-day 5.6% crunch, and are now ready for a test of the June 27 low of DJIA 17,063 (S&P 500: 1,991).
This, in spite of the fact that based on all factors, technical, fundamental, international, and economic, this market is overvalued. Both the bull market and economic recovery are historically up in years.

A stronger U.S. dollar stands to adversely impact Q3 and Q4, S&P 500 earnings, which the Street was counting on to justify these prices. The uncertainty of a presidential election stands to slow capital spending by companies until managements know who will be president.
Earnings projections for Q2 call for a drop of 5.3% vs. an estimate of a drop of 2.8% three months ago. While oil and related industries account for much of this decline nine (9) sectors have lower growth rates now than at Mar.31. This would bring the P/E for the S&P 500 to 16.4 compared to a 5-year average on 14.6 (data FactSet.com). A Q2 decline would be the first time Y/Y earnings have declined five consecutive quarters since Q3 2008 – Q3 2009, the Great Recession.
Much has changed since, we are not on the edge of a total meltdown. It does highlight how focused the Street is on Fed policy. At some point, the Street will return to basics. If earnings continue to slip, it would indicate Fed policy is not working, and the market will have to adjust for that. Earnings will have to pick up to justify the current P/E.
Earnings will be released in coming weeks. Along with that, the Street will have to deal with revisions of future earnings and corporate guidance. Expect those to be lower.
The stock-index futures indicate a lower market at the open. This is normal after a four-day 5.9% rally last week.
Obviously there is a healthy appetite for stocks out there, or markets would have plunged last week instead of rallying. I think investors and institutions are buying yield stocks, most of which are the hefty blue chips which mathematically impact the construction of the DJIA and S&P 500. Nasdaq stocks have been laggards in recent days.
There is risk in that strategy. Dividends can be cut, for one. Then too, if the purchase is poorly timed, a paper loss is possible, one which may take a long time to recoup.
SUPPORT “today”: DJIA:17,767; S&P 500:2071; Nasdaq Comp.:4,796
RESISTANCE “today” DJIA:18,001; S&P 500:2,113; Nasdaq Comp.:4,877.
On occasion, I technically analyze each of the 30 DJIA stocks for a reasonable risk, a more extreme risk, and an upside potential over the near-term. I add the results of each, then divide by the new DJIA “divisor” (0.14602) to get the DJIA for those levels. This gives me an internal check on the DJIA itself, especially if certain higher priced stocks are distorting the averages.
As of July 1, 2016, a reasonable risk is 17,798 a more extreme risk is 16,833. Near-term upside potential is 18,120.
(I will repeat this regularly to keep readers aware of the potential for an April correction)
The market is tracking a pattern for presidential election years where an administration is in its second term.* The news is bad.
Historically, these markets have declined in Jan./Feb., rallied in March then topped out in early April, plunged in May with brief rallies in June and August and a plunge into October prior to the election.
 STATUS OF MARKET: Neutral – but very, very vulnerable. Expect volatility
 OPPORTUNITY: RISK: Risk high, Profit taking justified.
 CASH RESERVE: 45%. Consider 75% now if tolerance for risk is low.
 KEY FACTORS: Outlook for Q2, and 2016 earnings questionable. Fed has market under its spell.
Note: Source of weekly economic calendar and good recap of indicators: mam.econoday.com.
George Brooks
Investor’s first read
A Game-On Analysis, LLC publication
Investor’s first read, is a Game-On Analysis, LLC publication for which George Brooks is sole owner, manager and writer. Neither Game-On Analysis, LLC, nor George Brooks is registered as an investment advisor. Ideas expressed herein are the opinions of the writer, are for informational purposes, and are not to serve as the sole basis for any investment decision. References to specific securities should not be construed as particularized or as investment advice as recommendations that you or any investors purchase or sell these securities on their own account. Readers are expected to assume full responsibility for conducting their own research pursuant to investment in keeping with their tolerance for risk.

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