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Wednesday, October 9, 2013

The elevation of Janet Yellen to replace Ben Bernanke as Fed Chair should help remove one source of uncertainty from the market, though the development was largely expected after Larry Summers was no longer in contention. The bigger source of uncertainty for the market is the budget fight in Washington that now appears on track to morph into debt ceiling fight. Investors are still hanging onto hopes that we will move past this issue before next week’s debt ceiling deadline, but each passing day brings unhappy reminders of how destabilizing the 2011 fight had turned out to be.

Janet Yellen is a known commodity for the markets, a strong advocate of Bernanke’s easy-money and transparent communications policies. The Bernanke Fed wasn’t very successful on the communications front, particularly with respect to the Taper question. They were unsuccessful in convincing the bond market that Tapering and tightening were two different things.

Perhaps the confirmation hearings will give us some clues as to how different she will be in communicating with the markets, but those hearings will have to wait for the current budget battles to end. Another development on the Fed front today will be the release of minutes of the last FOMC meeting when the central bank surprised the markets with the no-Taper decision.

Beyond the Fed and the Congressional fight, the 2013 Q3 earnings season has gotten underway. This morning’s reports from Costco (COST - Analyst Report), Family Dollar (FDO - Analyst Report) and Fastenal (FAST - Analyst Report) were broadly on the weak side, as was the report from Yum Brands (YUM - Analyst Report) after the close on Tuesday. But Alcoa (AA - Analyst Report) was broadly positive in its release, reiterating their favorable demand outlook for aluminum.

Including this morning’s earnings releases, we now have Q3 results from 26 S&P 500 companies. Total earnings for these 26 companies are up +7.9%, with 53% beating earnings expectations with a median surprise of +0.9%. Total revenues for these companies are up +5.1%, with 46.2% beating top-line expectations with a median surprise of +0.1%.

The earnings and revenue growth rates at this admittedly very early stage is tracking a bit better than what we saw from these same companies in Q2 and the 4-quarter average, while the beat ratios are roughly in-line with recent history.

A lot will be riding on guidance for Q4 given the elevated expectations for that quarter, when total earnings for the S&P 500 are expected to be up almost +10%. The overwhelming trend in recent quarters has been for companies to guide lower, prompting analysts to cut estimates.

It is still early in the Q3 reporting cycle, but that same trend appears to be at play this time around as well. If this trend remains in place in the coming days as well, we should brace ourselves for major estimate cuts. This could become a material headwind for the market beyond the current Washington fight.

Sheraz Mian
Director of Research

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