Fed watch is in effect as the two-day FOMC meeting gets underway today, a day after the stock market’s strong rally on the Summers announcement. In other news, this morning’s CPI reading was uneventful and the 2013 Q3 earnings season quietly gets underway today.
The Fed is expected to announce tapering its monthly bond purchases at the conclusion of its meeting Wednesday afternoon; the consensus expectation is for trimming of $10 billion to $15 billion from the $85 billion a month pace and wrap up the entire program by the middle of 2014. The market has taken the taper prospect in the stride, pushing stocks back to within striking distance of early August highs. This is in contrast to the prior two QE episodes at the conclusion of which stocks had sold off. Stock market investors appear to be more optimistic about the economic picture this time around, hoping that improved economic fundamentals and the resulting bump to corporate profitability will offset the impact of higher interest rates.
Recent economic data has for the most part been in the positive category. The last jobs report was underwhelming, but other labor market data has been favorable and the unemployment rate has been steadily coming down. The jump in interest rates as a result of the taper talk has dented some of the housing market gains, but the sector’s recovery may not be at risk as long as the labor market continues to improve. The factory sector is also showing signs of health, with ISM and Industrial Production data exhibiting renewed momentum. Pricing pressures in the economy remain muted as this morning’s August CPI numbers confirm. It will be interesting to see the Fed’s updated economic forecasts, particularly given the modes forecast upgrade at the June meeting.
The improved economic outlook has ultimately to show up in a stronger earnings picture. The 2013 Q3 earnings season that got underway this morning with FactSet Research (FDS) release and after the close from Adobe Systems (ADBE) will give us a sense of how good the earnings picture is through the quality of guidance for the following quarter. We are still a couple of weeks away from the full-fledged start of the earnings cycle, but the reports willl continue trickling in, including from FedEx (FDX) and Oracle (ORCL) on Wednesday. Expectations for Q3 have fallen enough that it wouldn’t take much effort for companies to come ahead of them, but estimates for Q4 still remain elevated and reflect a material growth ramp up.
The standard practice over the past year or so has been that companies beat expectations for the reporting quarter, but guide lower for the following period, prompting estimates to come down. That’s what happened in Q3 – the current +1.4% total earnings growth in the quarter is down from +5.1% expected at the start of the quarter in early July. The expectation for Q4 is for earnings growth exceeding +11%, the highest quarterly growth pace in a long time.
If the Q3 earnings season will be similar to what we have been seeing lately, then these Q4 estimates will start coming down in the coming days as companies guide lower at the time of releasing results. The question is will the market continue going up despite this underwhelming earnings picture or will finally start taking notice? We will find out soon enough.