IBM, eBay and Intel Spell Trouble – Gloomy Outlook. Rally Getting Stretched

July 18, 2013

The market continues to grind higher, but the headwinds are blowing. Earnings season is underway and we will hear from every sector this week. There were major announcements after the close and I did not like the news.

EBay had nice revenue growth of 14%, but profits were down. They cited weak conditions in Europe and Korea. Intel is still reeling from an 11% decline in PC demand. They forecasted flat sales next quarter and that was down from low single-digit growth projections. IBM exceeded estimates, but revenues and profits were down 3%. These bellwethers do not paint a pretty picture.

S&P 500 revenues are expected to grow 1.5% and profits are expected to grow 2.5%. Almost 1/5 of the companies warned ahead of earnings and negative adjustments outnumber positive adjustments by a ratio of 5 to 1. This is setting up to be one of the worst quarters in many years and it could be a sell the news event.

Financials have been strong thanks to the Fed. Banks have been able to borrow cheap and pocket the spread without increasing risk. Profits have helped them fortify balance sheets and US reserves are healthy relative to European banks. Should credit conditions surface, our banks should be able to hold their own. This is keeping the dollar strong and it is attracting foreign investment.

Healthcare should also post good results. Obamacare seems to be less of a concern and an aging America is good for business.

Oil stocks should also do well as prices start to climb. However, natural gas producers will struggle. Refiners are also pulling back as input costs rise. Overall, the energy sector will be a wash.

Yesterday’s numbers from IBM and Intel will weigh on the tech sector. PC demand is soft and companies are holding off on IT investments.

Basic material stocks will struggle as global economic conditions deteriorated. These stocks have bounced recently and they could present shorting opportunities.

Industrials will also struggle due to dire conditions in Europe and dwindling demand in China.

Retailers are gearing up for “back to school”. The results in this sector have been mixed and high-end stores have outperformed discounters. Ex-autos and gasoline, retail sales last month increased a meager .1%

Apart from financials and healthcare, the other sectors look weak. The market is at a 52-week high and earnings season will not fuel this rally.

Google, Microsoft, Honeywell, Whirlpool and GE will release before the open tomorrow. Google will post strong numbers and the rest will be mediocre.

Fed speak concludes today and the market is getting used to the idea of tapering. Monetary policy will remain accommodative. Even when bond purchases are reduced, the Fed is still adding liquidity.

Global economic conditions are slipping. China’s growth in 2013 is at a 23-year low and our economy is expected to grow 1% in Q3. Europe is in dire straits after six consecutive quarters of contraction.

I’ve painted a very gloomy picture, but I’m not looking for a market meltdown. I simply believe that resistance will be very heavy and the market will pull back into the middle of its trading range. Asset Managers will not chase stocks at an all-time high when interest rates are rising and activity is declining.

Record cash flows and strong corporate balance sheets will save the day. Companies are buying back shares and the float has been reduced by 50% over the last 10 years. A smaller supply of stock translates into higher prices.

In order for the market to rally, we need economic growth. The sequester needs to run its course and China needs to stabilize. That could take a couple of months to unfold.

The strongest companies announce early in the earnings cycle and I believe we will see the peak of this rally next week. Bullish speculators are getting sucked in and we are setting up for a nasty little decline.

Watch for negative earnings reactions. A red flag will be raised when companies beat estimates and decline after the news. You can trade from the long side for the next week, but be very selective and watch for horizontal breakouts. Use that breakout as your stop and keep your size small.

As you can tell from my comments, I am more inclined to go short than I am to go long. When the tone sours, I will be looking for stocks to short after they post earnings.
As long as the breakout at SPY $167 holds, I will look for bullish trades. When that support fails, I will be ready to shift gears. The last leg of this rally has come on very light volume and it is vulnerable.
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