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Wednesday, August 7, 2013

Taper fears are believed to be the reason for the stock market's Wednesday pullback and negative pre-open sentiment today. But this would make sense only if one started with the assumption that the stock market wasn’t pricing in some sort of Taper action later this year. The stock market isn’t blind to developments in the bond market and benchmark treasury yields haven’t budged much in either direction after spiking more than 100 basis points since May.

What this tells me is that the current bout of stock market tentativeness may be nothing more than an excuse to take easy profits in a slow news, low volume summer period. We have roughly six weeks to go before the next Fed meeting, which will most likely user in some sort of Taper. As such, I wouldn’t be surprised if this bleed down continues through the rest of August.

Taper fears may not be a good enough reason for investors to flee the market, but there is no shortage of other meatier reasons to do just the same. The most important of these reasons is the ‘iffy’ earnings outlook for the second half of the year and next year. The market’s strong gains thus far need to be confirmed by momentum on the earnings front. But we are witnessing the opposite of what should be happening at this stage. Estimates for the second half of the year in general and Q3 in particular are falling sharply as the Q2 earnings season has moved towards the finish line.

Stocks market bulls continue to hold out hopes for earnings growth ramp up towards the end of the year and next year - that's why estimates for Q4 and next year still reflect double-digit growth rates. They can justifiably point towards the improving macro backdrop like the recent strong ISM readings, the narrower trade deficit, the not-so-shabby jobs picture, and even some tell-tale signs of green shoots in Europe. But if we don’t see any evidence of positive earnings momentum, as has been the case thus far, then the bulls would need to come up with a more plausible justification for the market’s record level.

With the Fed getting ready to get out of the QE business, irrespective of whether the Taper comes next month or later this year, stocks need earnings power to justify current lofty levels. We haven’t seen that thus far. Is it any surprise then that investors are cashing in their gains before heading out to the beach? That’s exactly what they should be doing anyway, irrespective of what this or that member of the Federal Open Mouth Committee may be saying any given day.

Sheraz Mian
Director of Research

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