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As the new guy at Zacks, I thought I would introduce myself by providing a few thoughts as we enter the upcoming earnings season for Q2. 
 
First, I like to get a lay of the land from a historical perspective and examine seasonality.  July has tended to be a positive month for the S&P 500, but the breadth of the gain is not strong.   Going back to 1929, the S&P 500 has posted an average return of 1.48% in July.  Although July has produced the strongest average monthly return of the year, the S&P 500 has risen 48 of 85 months or just 56.5% of the time.   The average return in the 48 up months has been 5.14%, while the average return in the 37 down months has been -3.26%.   A number of other months have produced a higher percentage of positive return.    

Second, it might be worth noting how the S&P 500 has historically traded through the Q2 earnings season.   Convention wisdom sees Alcoa (AA), Zacks Rank 3, as the company which kicks off the season.    It is possible to use the Alcoa earnings event to benchmark the path of  the S&P 500 through earnings season.  The graphic displays a 5, 10, and 15 year average price movement of the S&P 500 ETF (SPY).  The price of SPY was benchmarked to the close of the day before Alcoa released earnings and examined for 20 trading days after Alcoa’s profit release.  The chart indicates the S&P 500 has tended to see price strength early in the Q2 earnings season,  but strength seems to fade as the season progresses. Additionally, the market has performed strongly in the past 5 years relative to the past 15 years.

 

Third, there is great uncertainty over the pace of economic growth and the outlook for profitability in Q3.  The JPM Global Composite PMI output component fell 1.5 to 51.4 in June and shows the global expansion muddling along.  Emerging economies, which have provided support to global growth, seem to be struggling, Europe continues to fight recession, and the U.S. economy is throwing off mixed signals. 

An 80%  non-manufacturing to 20% manufacturing mix of the ISM activity and production components fell almost 3.0 to 52.0 in June – the lowest since July 2009.  However, the economy also created 195,000 jobs in June and payroll growth seems firm.  

Fourth, recent profit releases from Accenture (ACN), Zacks Rank 3, Oracle (ORCL), Zacks Rank 3, and FedEx (FDX), Zacks Rank 3, were unable to generate great confidence in the profit outlook, and have probably generated some caution about the strength of Q2 earnings.   Signs of profit strength in early July could allow the market to reduce its focus on QE tapering and Federal Reserve policy.  Vibrant profit growth could also ease nervousness in the trade over the idea that higher interest rates will cap the economic expansion.  

Fifth, investor optimism is mixed going into earnings season. The American Association of Individual Investors poll of sentiment showed the bull index up 11.7 to 42.0 and the bear index down 11.4 to 23.8 in the week ending July 3rd. Individual investors seemed to have turned more constructive on the market.  A pick up in calming words from Federal Reserve members and recent price strength have helped to boost optimism.  However, the CBOE put to call ratio shows less bullish positioning.  The 10 day average was 1.05 through July 3rd and is consistent with a neutral to cautious view toward stocks.   Put volumes have slightly outpaced call volumes.   

Sixth, watch what Alcoa says about end demand for its products.  Autos and aerospace have been strong sectors and were seen growing 1-4% and 9-10% respectively in 2013 at the end of Q1.  Heavy trucks and commercial construction demand was projected up 2-7% and 4-5% respectively in 2013.  A downgrade to these assessments may influence the demand for cyclical shares, and the overall economic outlook. 

Likewise, the market will be sensitive to the outlook for China’s aluminum demand, which had been projected up 11% in 2013.  Demand for the World excluding China was expected up 4% in Alcoa’s Q1 press release.  European and North American aluminum demand was seen down 1% and up 4% respectively in 2013.

Seventh, the market will be watching to see if rising interest rates have translated to stronger bank profits, and earnings momentum in the banking sector.  Bank shares have hit new highs in recent days based on the price movement of the SPDR S&P Bank ETF (KBE).  A strong bank sector is likely to support the overall tone of the market - a bull market needs leaders.  Thursday, July 11th, Commerce Bancshares (CBSH), Zacks Rank 3, and Bank of the Ozarks (OZRK), Zacks Rank 2, report earnings, while Friday, July 12th Wells Fargo (WFC), Zacks Rank 3, and JP Morgan (JPM), Zacks Rank 2, report profits.

I’m excited about the trading environment in the coming weeks.  Buckle up your seatbelt and be ready to grab the opportunities as they present themselves. 

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