08 July 2011 at 20:45 GMT
Next week will mark the beginning of the second quarter earnings season in the U.S. with Alcoa kicking off on Monday after the close, as usual. JP Morgan and Google follow on Thursday and Citigroup on Friday respectively. These are the notable earnings reports next week. U.S. banks are likely to disappoint as a whole, due to slow trading conditions and continued consumer deleveraging, but expectations are already low for this sector so the negative surprise should be limited.
Over the last couple of years, earnings seasons have consistently supported equity markets and this time should be no different. Indeed, only a little more than a week after the end of the quarter, we believe that most large corporations know if they have a serious earnings miss on their hands.
We note the fact that none of the heavyweights have issued pre-warnings as a sign that major misses should be avoided. The major recent profit warnings were issued by Phillips and Nokia but these were mainly due to company specific issues, not the overall economy. Guidance for the third quarter will be the factor to watch in this earnings season as companies will in this manner offer their views on the strength of the U.S. economy.
The market still seems to be pricing in an economic upswing in the U.S., as we touched upon in our previous two posts. A confirmation of this trend is further highlighted by the Dow Jones Transportation Average posting a new all-time high this week:
Dow Jones Transportation Index – source Bloomberg
The bears will argue that this is a blowout and the ugly non-farm payrolls survey released today may well prove them right. Economic figure releases next week such as Advance Retail Sales on Thursday and Empire Manufacturing and Industrial Production on Friday will therefore be worth their weight.
Yet, we see another interesting development illustrated by the strong outperformance of the Nasdaq 100 index versus the S&P 500:
Nasdaq 100 versus S&P 500 – Daily chart (source: Bloomberg)
Technology should performwell in a growth situation, so the above breakout, whilst still needing confirmation, shows that from that angle the market is also pricing economic growth as its base scenario.
What’s more, if you consider that the top seven stocks of the Nasdaq 100 (AAPL, MSFT, ORCL, GOOG, INTC and QCOM) represent close to 45% of the index capitalisation and exhibit overall strong positive short-term momentum, then this outperformance looks likely to hold at least during an earnings season which is expected to be rather positive.
Against this U.S. backdrop, Europe remains the big question mark. We are still awaiting the results of the infamous bank stress tests and the general feeling is that it might be another application of the ostrich strategy (aka “stick your head in the sand”). More to the point, the political wrangling over the terms of the Greek debt rescheduling will remain high on the agenda, with the European Central Bank reaffirming this week that any type of default must be avoided at all costs by European Governments.
As a result, the Stoxx 600 banks index still offers a bleak picture as the sector remains under heavy pressure despite the recent rally in the overall market:
Stoxx 600 Banks Index – Daily chart (source: Bloomberg)
As we highlighted in a recent post, the line in the sand for the sector remains at the 170 level. below which the market would start pricing something nasty for the European banking system, if history is of any guidance.
The technical picture at the index level reflects the apparent fundamental divergence between the U.S. and Europe that we have highlighted above. After cleaning the 1,345 resistance with some ease, the S&P 500 is duly rattled by the non-farm figures:
S&P 500 - Daily chart (source: Bloomberg)
The close today will therefore be very important to watch to get an idea of the risk appetite for next week. Should the index find a base around 1,340 today, we could well see a test of the recent highs at 1,371. Otherwise, all bets are off and we will be looking for a new test of the 1,315 – 1,300 support into next week.
For Europe, the Euro Stoxx 50 remains a death trap with a lack of clear trend. The below distribution of volumes on the front-month futures contract shows the support levels quite clearly for next week:
Euro Stoxx 50 futures – volume distribution over 30 days (source: Bloomberg)
Short-term support comes in at 2,800, followed by 2,775 with major support in the 2,735 – 2,725 area. Resistance remains in the 2,850 – 2,860 area.