Stocks Fall As Earnings Season Begins: 07.11.14

The Long-Awaited Pullback Has Arrived. Will It Stay?

Stocks pulled back last week as Q2 earnings season officially began. So far this appears to be another normal and healthy shallow pullback in both size (% decline) and scope (short duration).  Remember, shallow pullbacks are healthy as they give the market a chance to pullback and digest the recent move. The good news for the bulls is that nothing has changed. From a fundamental point of view, the Fed Put is alive and well (The Fed Put refers to the notion that if either Main St or Wall St fall hard the Fed will step in again and print more money – another round of QE) and the strong technical picture (price action) remains healthy. The market remains exceptionally strong in all three time-frames: short, intermediate and long. In the short term, the major averages were just extended in the short-term and overdue for a nice pullback. The best way to interact with markets is to focus on what is happening right now (known) and avoid the temptation to predict the future (which by definition, is unknown). That said, right now we are in a very strong bull market and weakness should be bought until further notice.

MON-WED: Pullback Begins

Stocks opened lower on Monday as investors returned from the July 4th holiday. Market attention shifted from record highs to the start earnings season and whether or not the Fed will increase interest rates sooner than initially expected. European stocks fell about a percent after industrial production data for Germany came in weaker than expected. Germany is Europe’s largest economy and a slowdown there may adversely affect the broader European economy. Stocks fell on Tuesday as Q2 earnings season officially began. After Tuesday’s close, Alcoa (AA) officially kicked off earnings season and jumped after hours. The VIX (a.k.a. Chicago Board Options Exchange Volatility Index), a measure of investor unease, rose nearly 6% percent, to 11.98, after falling to “an astoundingly low 10.3 following Thursday’s jobs report. The VIX does a good job of measuring fear, not volatility. The historical norm is in the mid teens so a reading under 12, still signals complacency. Stocks rallied nicely on Wednesday after the Fed released the minutes from its latest meeting. The minutes. The minutes showed that the Fed will largely stay the course but has begun discussing the subject of raising rates and largely agreed that the final taper for QE 3 will occur in Oct 2014. Stocks rallied because the Fed largely stayed the course and did not make any major changes. 

THURS-FRI: Stocks Fall on Europe & China Woes

On Thursday, stocks fell and were dragged lower from disappointing data from China & Europe (mainly Italy and Portugal). Several of Portugal’s largest banks fell hard (over 10%) as fear spread they will not be able to remain solvent and may need outside assistance. Stocks were relatively quiet on Friday as investors digested the latest round of earnings and M&A news.  Wells Fargo (WFC)  opened lower but closed near its highs on the day after reporting Q2 results. We are now entering the heart of earnings season as scores of companies will be announcing Q2 results over the next few weeks. As always, we pay more attention to how the market reacts to the numbers, not just the numbers. Lorillard (LO) rose and Reynolds American fell after the tobacco companies confirmed merger talks.

MARKET OUTLOOK: Strength Begets Strength

The key now is to measure the health of this pullback to see if it is just another shallow pullback within an uptrend, or the start of something more severe? Keep in mind that this bull market is aging (turned 5 in March 2014 and the last two major bull markets ended shortly after their 5th anniversary; 1994-March 2000 & Oct 2002-Oct 2007) but until we see signs of distribution (heavy selling) the market deserves the bullish benefit of the doubt. As always, keep your losses small and never argue with the tape.