An Inconclusive Start to the Q2 Earnings Season?

Good Evening: After an upside surprise from Alcoa and much better than expected initial jobless claims, U.S. stocks were poised to go much higher this morning. Given the almost 10% pullback in some of the major averages during the past four weeks, the news portended some short-covering, or at least a decent sized bounce. Unfortunately, the rally was mostly a no-show today, as the initial upticks were met with shrugs and even some selling. Though some risk-taking was evident today, the set up going into the real earnings reporting season (which begins next week) would, on the surface at least, appear to be inconclusive.

Stocks in Asia mostly continued their recent losing streak last night (stretching the skid there to seven straight days for Asia in the aggregate), but U.S. stock index futures chose to follow the bourses in Europe, which were up 1% or more prior to the open in the U.S.. Alcoa kicked off the Q2 earnings season by beating analysts’ estimates last night, and this news also helped boost our stock index futures. Calling Alcoa’s results an “earnings beat” is a misnomer, for while AA posted numbers ahead of Street estimates, the company’s bottom line was still red to the tune of almost half a billion dollars. Still, market participants were encouraged enough by AA’s results to push U.S. index futures higher prior to the jobless claims report.

Though he didn’t mean to do so, CNBC’s Rick Santelli then set the tone for the entire trading day when he disclosed the jobless claims figures to viewers. First came the good news (initial claims dropped well below the “magic” 600K mark), and then, less enthusiastically, came the bad news (continuing jobless claims jumped to a new record high). In response, and in keeping with the sequential theme hinted at above, index futures popped in celebration of the hefty fall in initial claims. For a good explanation of why the claims data later came to be viewed with some suspicion (i.e. seasonal adjustments played a role), please see the BAC-MER report below. Today’s data did nothing to dispel the notion that we have a large and growing unemployment problem. As I noted in my previous market commentary, even those with jobs are working fewer and fewer hours. What I neglected to mention about the chart I used to back up this assertion is that it came to me courtesy of Philip Grant at CF Global (my apologies, Philip).

The interest in equities inspired by AA and jobless claims didn’t spark much upside momentum once trading commenced in New York, however, and the major averages could only manage gains of just more than 0.5% in the early going. Perhaps contributing to this morning’s dullness were the mixed to disappointing June chain store sales which dribbled out during this time frame. Adding some noise was the official “Public-Private Investment Partnership” announcement, but the scaled down nature of this latest version of the PPIP — and PIMCO’s mysterious withdrawal from it — led to an understandably muted market response. Credit did catch a bit of a bid, and shares of financial companies did creep higher.

The rest of the session was then spent going sideways until a modest late day sell-off trimmed this morning’s gains. The S&P and Dow Transports did cling to gains of just under 0.5%, but the Dow Industrials and Russell 2000 fell back to finish virtually unchanged. In addition to the summertime blahs, the poor results from today’s auction of 30 year Treasury bonds may have also hampered equities (see below). After the stellar 3 and 10 year note auctions that preceded it, there was a demonstrated lack of enthusiasm among investors to lend the U.S. government funds for three decades at a mere 4.3%. The G-8 meeting may have been a complicating factor in tendering those bids, since a bland communiquĂ© belied a behind the scenes squabble about the future role of the U.S. dollar (see below). Currency traders were not fooled by the G-8 statement, and they marked down the U.S. dollar index by more than 1% on Thursday. Needing some good news after recent drubbings, commodities went up as the greenback went down. Grains and copper were the standout performers as the CRB index rose 1.4%.

One of the questions most asked both on trading desks and on cable T.V. today was: “Is the earnings news from Alcoa going to be indicative of Q2 earnings for the rest of the tape?” The answer is obviously unknowable in advance, but the action in AA was interesting. After jumping over a bar that had been set pretty low, AA parlayed that smaller than expected loss into a gain of more than 5% last night and this morning. Interestingly, though, this “beat” wasn’t enough to prevent Alcoa’s stock from sliding until it finished down by almost 2.5%. For those who think a company’s “guidance” is more important than the actual earnings, this decline was registered in spite of some hopeful statements by AA’s CEO.

I don’t know if the rest of earnings season will play out for others the way it did for Alcoa today, but the set up is intriguing. The major averages enjoyed a 30+% rally off the March lows into April and May, only to see June go sideways. The green shoots advocates were sure the bottom was in for the stock market and that the economy would follow in Q3. The shocking drop in consumer confidence on June 30 then challenged these assumptions, and last week’s unemployment figures triggered a decent correction in stock prices. The battle lines are thus drawn between the following camps. There are those who believe a torrent of cash will come pouring in off the sidelines when companies meet or beat the downwardly revised Q2 estimates, and there are others who have fresh worries about the economy and may not have sold much before last autumn’s fall.

We’ll find out in the weeks to come, but I could easily see the market rising or falling 10% during the next month. We could even see both outcomes if today is any indication. Remember that the financial stocks report early in the cycle, and with asset prices rising during Q2, it’s quite conceivable many of them will report outstanding results (especially if they can still mark their toxic assets however they see fit). There are many investors who believe financial stocks hold the directional key to the stock market, and good earnings news from this sector could propel a rally in the whole tape — especially after the swoon since the mid June high in the S&P. Of course, a slew of earnings disappointments will have the opposite effect, potentially opening the trap door to a retest of the March lows.

The pivot point might just end up being the release of the July employment data on August 7. By that time, the earnings picture should be a little clearer, making the employment picture the crucial variable. Alcoa achieved much of its “success” last quarter through severe cutbacks in jobs and other expenses management deemed easy to throw overboard. This strategy, while worthy of an “A” in just about any of our nation’s business schools, only works in the micro sense. From a macro perspective, the more companies that adopt the “slash and burn the expenses” strategy, the larger the negative impact on aggregate demand. If too many companies chop the head count to please analysts and shareholders, then a smart strategy will soon become a vicious cycle. Decision making at the micro (company) level takes on greater importance in the wake of a broken credit bubble. Just ask Japan. Hmmm; maybe Alcoa’s earnings report and topsy turvy stock action are a far from inconclusive start to the Q2 earnings season after all.

— Jack McHugh

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Initial claims better cont cla.pdf

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