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Taper Timing is the Only Issue Now

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Friday, November 1, 2013

The stock market had impressive gains in October, but ended the month on a weak note following renewed uncertainty about Fed policy. With the third quarter earnings season now winding down and economic data generally less informative given the effects of government shutdown, it is reasonable to assume that the market will likely remain preoccupied solely with Fed relative issues in the coming days and weeks. The key question for the market now is whether Taper is a December event or something that is unlikely to take place before April 2014.

On the data front, the manufacturing ISM report coming out a little later is expected to pullback modestly from September’s 56.2 level, but still remain firmly in expansionary territory (readings above 50 indicate expansion). The odds of a positive ISM surprise are fairly high given what we saw from the Chicago PMI on Thursday. Given the Chicago PMI’s strong historical correlation with the national manufacturing ISM index, the regional index’s strong showing on Thursday bodes well for the national reading.

We also got  the official Chinese PMI readings for October today, which mirrored the improvement in that country’s factory sector evident from the earlier private-sector readings from HSBC Bank (
) and Markit. PMI readings from other countries in Asia, notably South Korea, Taiwan, and Indonesia also show momentum, but exports appear to be lagging across the region including in China. The Chinese PMI’s export sub-component shrank in October, likely indicating continued weakness in the country’s export sector that was spotlighted by the modest export decline in September. International trade in general and exports in particular play an outsized role in the region’s economies and weakness on that front will continue to cloud the region’s broad growth outlook.

On the earnings front, the Q3 earnings season has started winding down. Including this morning’s reports from Chevron (
(CVX - Free Report) ), NextEra Energy ((NEE - Free Report) ) and Northeast Utilities (), we now have Q3 results from 365 S&P 500 members that combined account for account for 78% of the index’s total market capitalization.

Total earnings for these 365 companies are up +4.6%, with 67.4% coming ahead of consensus earnings expectations. Total revenues are up +2.8% and 52.9% are beating top-line expectations. The composite earnings and revenue growth rates for Q3, combining the results for the 365 companies that have reported with the 135 still to come, are +4.1% and +2.5%, respectively.

The Q3 earnings started off weak, with companies struggling to meet lowered expectations and growth rates tracking below recent quarters. But that changed as the reporting cycle unfolded, with Q3 now on track to surpass the performance of the first two quarters of the year. There is still not much growth and most companies are still guiding lower, prompting estimates for Q4 to come down. But when all is said done about the Q3 earnings season, we will have a new quarterly record for total earnings and the quarter’s earnings growth rate will likely be the best thus far this year.

This performance seems to be good enough for investors to push stocks to new all-time highs, but it doesn’t answer our long-held doubts about earnings growth in the coming quarters.

Sheraz Mian
Director of Research

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