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Tuesday, May 6, 2014

Stocks will likely continue their listless and directionless behavior of recent days, with today’s positive data out of Europe insufficient to give stocks much of a lift. We don’t have much in terms of positive catalysts to move stocks higher. The Q1 earnings season is now effectively over, and the bond market’s reaction to the recent run of positive economic data has take some of the shine off of the optimistic growth projections.

This isn’t a favorable backdrop for the market.   

The composite PMI survey for the Euro-zone, which combines the region’s manufacturing and service sector surveys, came in-line with expectations at 54. The readings in the region’s weaker economies showed particular momentum, with Spain’s PMI reaching its highest level since the crisis at 56.5, up from March’s 54. Italy’s reading went above the 50 level and the U.K. also came out with a better than expected read (though it’s not part of the currency union).

The uncertain Ukraine situation on the region’s doorstep remains a cloud, but the overall outlook for the region’s economic has been steadily improving. This has yet to show up in inflation expectations which still remain below the European Central Bank’s target. But these favorable economic readings make it increasingly unlikely that the ECB will go for any aggressive easing measures in its Thursday session this week.

The improved European backdrop has been a theme that we have been hearing about throughout the Q1 earnings season. Including this morning’s reports from Mosaic (MOS - Free Report) , Emerson Electric (EMR - Free Report) , DIRECTV and others, we now have Q1 results from 392 S&P 500 members that combined account for 85.2% of the index’s total market capitalization. Total earnings for these 392 companies are up +0.8% from the same period last year on +0.3% higher revenues, with 67.7% beating EPS estimates and 48.5% coming out with positive revenue surprises.

This performance is weak, but all or most of it was known ahead of time, as estimates had come down sharply ahead of the start to the Q1 reporting season. Many had been hoping, however, that we wouldn’t see similar negative revisions going forward. But we are not seeing that, with estimates for Q2 coming down along the lines of the trend that we have been seeing quarter after quarter for almost two years now.

With about 5 weeks into 2014 Q2, total earnings for the quarter are currently expected to be up +3.5% from the same period last year, down from +4.2% last week and +5.5% at the start of the quarter. The J.P. Morgan (JPM) warning last week about continued capital markets weakness is starting to flow through to estimates for other Wall Street firms that will put further pressure on aggregate Q2 estimates. And we will likely see something similar to play out in the coming round of retail sector earnings reports.

It is hard to see corporate earnings serving as a catalyst for the market in absence of any improvement in this ongoing negative revisions trend. We didn’t see the improvement this earnings season, but hopes remain high that the second half of the year will be better. If that is the case, then we should start seeing some evidence of that in the June quarter results. The best that can be expected of the market in the meantime is to just tread water in the coming seasonally weak period.  

Sheraz Mian

Director of Research

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