Correction And Bounce: SPX Off 10% From Highs Intraday As Weak Earnings, Outlooks Crush Stocks

After flirting with correction territory late last week, stocks look poised to post some early gains Monday. The question is whether any morning strength can last through the day, with the market still on pace for its worst month in almost a decade.

It’s hard to capture sentiment in a nutshell, but one way to think of the current situation is to see it as a readjustment. Many investors seem to be looking at company outlooks amid the current geopolitical mood and deciding that previous valuations may no longer be appropriate

Today isn’t scheduled to bring much in the way of milestone company reports, but this week is set to be one of the busiest of the earnings season (see more below). So far, 77 percent of S&P 500 companies have beaten Wall Street analysts earnings per share estimates, compared with the five-year average of 71 percent, according to FactSet. Also, 59 percent of companies have beaten on sales, in line with the five-year average. 

On the corporate front, IBM IBM announced the $34 billion purchase of Red Hat Inc. RHT in a deal designed to enhance IBM’s cloud division. Recall that earlier this month, IBM reported slowing cloud sales in an earnings report that many analysts saw as disappointing. Shares of IBM slumped to nine-year lows following the Red Hat announcement. 

All major indices finished last week with sharp losses. This week brings the end of this stomach-churning month, along with another full batch of earnings and data—including a jobs report and results from Apple Inc. AAPL. Overnight saw another plunge in China’s stock market, but some positive traction in Europe. The closely watched 10-year U.S. Treasury yield clicked up slightly to 3.09 percent, but remains well under the month’s highs above 3.25 percent.

One thing to consider keeping an eye on this week is the FAANGs. As we saw last week, action in these five stocks tends to boomerang around the market. When Amazon.com, Inc. AMZN and Alphabet Inc. GOOG GOOGL retreated last week, it helped drag the market with them. AAPL’s earnings later this week, scheduled for after the close Thursday, could loom large.

Earnings Keep Rolling In

Apple is arguably just the tip of the iceberg in a week that, when finished, will see the majority of earnings season completed. Other key company reports include Facebook Inc. FB, The Coca-Cola Co. KO, General Motors Company GM, Alibaba Group Holding, Ltd. BABA, Chevron Corporation CVX and ExxonMobil Corporation XOM. 

It might be a good idea to keep listening to company conference calls, because so far they’ve likely been behind some of the negative sentiment these last few weeks. Companies across many industries have been expressing concerns about a stronger U.S. dollar, higher energy costs, and tariffs all taking a toll on current or future performance. United Parcel Service, Inc. UPS, Anheuser-Busch Inbev NV BUD, and Illinois Tool Works Inc. ITW were among the companies last week mentioning foreign currency struggles.

That’s kind of what many analysts had feared going into earnings, and points up how even strong quarterly performance often isn’t enough to give stocks a boost if investors are fretting about the future. The dollar index rose intraday Friday above 96.80, near its yearly high, before retreating slightly. Many companies say foreign exchange has been and could continue to be a challenge. GM, KO and AAPL all could be interesting to hear on that aspect of things when they report, considering their large international businesses. CEO calls are more important than ever.

Some Investors Seem To Be Readjusting Expectations

So what we might be seeing here is a simple readjusting of expectations among many investors as these troubles start to hit earnings. It’s arguable that the fundamentals behind many stocks, including AMZN and GOOG, haven’t changed all that much. What does seem to be changing is the multiple some investors are willing to pay for those companies as they look down the road and perhaps see a little less opportunity for growth, especially considering all the outside fundamental issues mentioned above. Even companies with positive guidance see their stocks struggling, and those with negative guidance are getting hammered.

Except for the late sell-off Wednesday, the downturn has mostly been orderly. There’s little panic selling. Instead, many investors seem to be selling a little and then sitting back to see what might happen next. This process could continue throughout earnings season. Also, every day has had a few green patches where certain sectors have shown a little strength. This could be seen as healthy.

Still, volatility remains elevated and there’s little reason to expect that to change in the coming days. With that in mind, investors might want to consider trading small as long as they don’t mind increased trading costs. That means if someone normally trades 1,000 shares, they might want to consider trading 300 or 400 instead, at least while volatility continues to surge. Things are moving fast, and you don’t want to jump in front of a freight train. Also, people who trade using stops should consider widening those as long as volatility remains high. VIX, the market’s most closely watched “fear index,” climbed above 26 Friday, well above the historic average of mid-teens.

Payrolls, Inflation Data Coming Into View

The new week promises a wealth of economic data, highlighted by Friday’s U.S. payrolls report for October. Recall that in September, job growth of 134,000 was well below analysts’ estimates, but the unemployment rate fell to near 50-year lows and wages, while up, arguably stayed out of “overheated” territory. Investors awaiting the October data should keep in mind that any wage growth of more than the 2.8 percent year-over-year rate seen in September might fuel concerns about inflation and a possible hawkish Fed reaction.

Even in light of the stock market selloff, futures prices indicate a nearly 65 percent chance of a rate hike before the end of the year. While that’s down from above 80 percent a few weeks ago, odds still seem pretty high that a fourth rate hike is in store. However, chances for a follow-up rate hike in March took a tumble last week and currently sit below 40 percent, from above 50 percent just a week ago, according to CME futures. 

The jobs report might give a sense of the inflation picture, but there’s nothing like actual inflation data for that, and investors get some Monday with Personal Consumption Expenditure (PCE) prices. The Fed looks very closely at these, so investors should consider doing the same. The data Monday for September showed a 0.1 percent increase in PCE prices, in line with analysts’ expectations. Core prices rose 0.2 percent a little above the 0.1 percent that Wall Street had dialed in. Personal income in September rose 0.2 percent, below the 0.4 percent consensus estimate. 

FIGURE 1: FLIGHTS TO SAFETY? Though the U.S. Dollar Index (candle chart) sometimes sees strength during times of extreme market volatility (as shown by the Cboe Volatility Index—VIX—purple line), that's not always the case. The two have moved in tandem, however, over the last round of October volatility. Image sources: Cboe Global Markets, ICE. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results. 

Pulling Back the Curtain on Data

While headline data can provide a helpful snapshot, it often helps to dig under the main number to get a little more insight. Investors who did that with Friday’s key data—GDP and Michigan sentiment—might have noticed there was more than meets the eye to both. For instance, even though the headline Q3 GDP growth of 3.5 percent beat analysts’ consensus of 3.3 percent, the report showed very slow growth of just 0.8 percent in company investment during the quarter, down from more than 11 percent in Q2. That could raise questions about whether companies see enough economic justification to re-invest in their businesses moving forward. Inventories grew, but could have reflected some companies loading up on goods ahead of time to beat looming tariffs on Chinese imports.  Also, consumer spending rose sharply, perhaps due in part to the tax cut. Another really big growth area was government spending, which can stimulate the economy but by its very nature typically isn't seen in the same light as consumer and company spending.

The Michigan sentiment headline number of 98.6 seemed healthy enough and didn’t point to any feverish overheating among consumers. It was down slightly from the year’s highs, but above its lows. However, consumers in the survey said they see inflation ticking up next year to nearly 3 percent, though they expect it to moderate in the long-term. “Importantly, stock price declines, rising inflation and interest rates, and the negative midterm election campaigns, have not acted to undermine consumer confidence,” Richard Curtin, director of the University of Michigan consumer survey, said in a statement. “Needless to say, consumers are not immune to these factors.”

Balance Beam

Often during the last two years, long-term investors heard that they should check allocations to make sure the rally hadn’t caused their portfolios to weight toward equities beyond their comfort levels. After all, if stocks get on the express elevator straight up, it’s likely that a portfolio would swell from those gains, raising the percentage devoted to stocks without an investor doing anything.  Someone who wanted, say, 50 percent of a portfolio to be in stocks and 50 percent in fixed income, might suddenly find themselves at 60-40. The key is to take a look every quarter, or at mid-year, and calculate whether the percentages moved out of line. At that point, the investor could re-balance by weighting the portfolio back to the original comfort zone. This correction we’re in now might turn the tables a bit. At this point, with around half of S&P 500 stocks down 20 percent or more from their peaks and the S&P 500 (SPX) and Nasdaq (COMP) officially in correction, those losses might mean some investors aren’t weighted enough toward stocks. Long-term investors might want to take a look this weekend (if they can bear facing those losses), and make sure they’re still comfortable with the proportion of their portfolios dedicated to equities. It’s called rebalancing, and can be done when the market is going down or going up.

Amazon Cruise

One interesting note about AMZN that stands in contrast to all the bearish stock movement Friday: Its quarterly earnings keep rising, and have been going steadily up now for about three years. It’s getting harder to remember the days when some investors dismissed AMZN as an all sales, no earnings story. Now many seem worried about the company’s revenue, especially slowing growth in its online retail sales, even as earnings grow and grow. The price-to-earnings ratio remains very high, but it’s no longer infinite, perhaps a sign that the company is evolving over time especially as it ventures into conceivably more profitable ventures like cloud computing and advertising.

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