Will Earnings Provide Direction?
It has been a choppy couple of weeks as trade war headlines have really been the only game in town. A lack of news has led to a focus on the battles which is typical of a quiet period (think the bitcoin frenzy in December). Throughout the ordeal we have been seeing a relatively tight consolidation pattern forming. However we are now riding into the meat of earnings season and the S&P is threatening to break above that 2800 area. But early reaction to earnings has been relatively muted and a miss by one of the FANGs (Netflix) has led to some questions around tech valuations.
Focusing on the S&P that area has been in the 2700-2800 since that May rally. The 100-sma (Currently 2718) and 50-sma (Currently 2752) have been providing support. But the bulls have yet to score a decisive rally above 2800.
CHART Trader Market Thoughts
- We have seen some really good trading action over the past month from my perspective -- a lot of strong top-down setups driven by big macro themes around trade and central banks. We also saw the VIX get up to nearly 20, which provided very good two-way trading in equity futures. But we are now heading into what sizes up as a very strong earnings season. Expectations are high, but the giant equity fund outflows we saw in mid-June (second biggest all-time w/w outflow) created an imbalance that is now forcing money to chase back in. To me, that adds up to an expectation of some quieter action for top-down traders until we get into the back half of earnings and past the FAANG stocks.
A Look at Q2 Earnings Expectations
Expectations for the upcoming earnings are high and that will set up for a key test for the bulls. To wit, what happens if earnings comes in as better than expected (which is usually the case for approx. 65-70% of the reporters on a quarterly basis) and yet we fail to find buyers? That could take the strong earnings out of the equation as most will view valuations as peaking. Then the market is looking at a wall of worries on the trade and geopolitical front and the specter of a very contentious mid-term election period.
- Cumulative Analyst expectations are for earnings to grow 20% y/y while revenue is expected to increase by approx 8.7%. As we know, companies tend to outpace expectations. A figure closer to +23-24% for EPS and 10%+ for revenues is what the market wants to see.
- Q3 earnings and revenue projected to be +21.7% y/y and +7.6% y/y, respectively' Q4 earnings and revenue growth expected to be +17.9% y/y and +5.8% y/y, respectively; As we can see we are getting closer to a peak earnings which will be further exacerbated by tough comps.
- 20 S&P companies have reported Q2 results with 85% beating earnings and 90% beating sales expectations. 62 companies have issued negative Q2 guidance compared to 47 who have issued positive. I would not be overly concerned about this as we usually see companies with negative expectations try and get out ahead of the actual earnings report.
- Energy is expected to post the strongest y/y increase as they continue to stack up against easy comps and are boosted by rising oil prices which are up over 40% from the prior year (XLE).
- Materials is also expected to see a strong y/y increase on both the top and bottom line. This should be one of the more interesting reads on earnings though as we will likely see some cautious guidance due to trade uncertainty (XLB).
- Telecomm is expected to be a winner in this upcoming earnings season, IT is next up on the earnings expectation but we probably want to focus on revenue growth which is expected to roll in close to 10% on a y/y basis. Again, trade commentary and the impact on earnings will be key (XLK).
Some Trading Ideas
- SCALP Plays:
- From my perspective, the markets have been boringly profitable the past couple of months. I continue to take advantage of short-term volatility in Chinese entertainment names such as HUYA, BILI and IQ to enter intraday scalps and multi-day swing trades... Rinse and repeat... I'll keep at it until the pattern breaks.
- You don't hear much about income strategies these days, but have seen strong performance in our Yield Portfolio as rates have come off recent highs. For example, Two Harbors Preferred A (TWO/prA), which pays 8.125%, has rebounded to 52-wk week highs. Targa Resources Preferred A (NGLS/prA), which pays 9%, has also traded back to 52-wk highs.
So far, it has been a low-stress, profitable summer. When things get this relaxed, I've learned that that it makes sense to start considering some hedges. The 3x Short Biotech ETF (LABD) is starting to look attractive here. I may start building a position in the coming days.
- EVENT Plays:
- On the idea front, there are two themes I am liking at the moment. Both are longer term in nature. The first is a long in Consumer Staples (XLP) as it has been one of the more beaten down spaces but is seeing a resurgence the last couple of weeks. I have taken a few of these plays (most notably GIS) as investments. And the recent slip in interest rates, which I believe have topped out for the moment, is leading to those dividend payouts to look a lot more attractive. So I will be taking a longer term play in the XLP.
- The other area that I am looking at is the 3-D printing plays (DDD, XONE, VJET, SSYS) and adding to the ROBO ETF. The way I see it, we are at a trade war with China and one of the key areas will be who can product more at lower costs. That will determine the winner. We will never be able to compete with China on its labor. Simple math on population and a cheaper labor force makes this a losing proposition. However, technology could even the playing field by producing through robotic and AI. And 3-D printing continues to gain in stature. I think these are two areas that you need to have exposure to in your long term portfolio.
- CMDTY Plays:
- I've been focusing on the energy space lately and I am still bullish on oil prices. I'm still in the buy-on-the-dip mode.
- At the same time, oil stocks have been underperforming oil, many of them easily underperforming, so I'm still cautious on oil stocks overall, given the divergence. I'm not sure yet if I'm seeing that as an opportunity.
- In agriculture, farmer income is concerning to me, and when combining this with the trade war going on with China, I'm cautiously look at this space as well. Fertilizer maker MOS is a name on my short radar. I can't wait to see cos outlooks with earnings season coming up here.