Stocks have been in a deep slump since July 22. Is it a
for most companies in the S&P 500 was winding down during this
time? As corporate commentary grew quieter, there were fewer fresh
positive data points coming to help offset the building global
As a quick recap, corporate profits remain exceptionally strong,
yet the broader macro environment, led by crises in Washington D.C.
and Europe, has been brutal. Will this coming earnings season,
which kicks off on Monday, Oct. 10, bring the spotlight back into a
more positive focus? There are solid reasons for optimism and
pessimism. Simply put, continued solid quarterly results, paired
with correspondingly bright forward outlooks, can no longer be
taken for granted in this shaky global
. Here are four themes you need to closely monitor before making
any further buy or sell decisions.
1. Big vs. small; U.S. vs. global
Even as blue-chips stocks have slumped, small caps have had an even
rougher time these past few months. In the past three months, the
S&P 500 has slid about 15%, while the
Russell 2000 Index
for small caps, has slid more than 20%. Many small-cap stocks are
off 30% or even 40% since the July
But this trend may soon reverse itself, so the safe haven provided
by large-cap stocks my not prove quite as safe. The S&P 500 is
reflective of global economic activity, because blue chips, on an
aggregate basis, now derive more than third of sales and profits
from foreign markets. This could prove especially troublesome for
companies with have a high degree of exposure to Europe, such as
Procter & Gamble (NYSE:
. The major European economies appear to be slipping into
, while the U.S. dollar has rallied against the euro. Taken
together, these factors are likely to dampen foreign-sourced
profits for many blue chips.
In contrast, smaller companies tend to have much less foreign
exposure. Sure, the U.S. economy has been tepid, but recent data
points -- such as the Institute of Supply Management (ISM's)
manufacturing and service surveys -- have been a little better than
many had expected. In addition, the United States still looks
better positioned than Europe in terms of a possible slip into
As earnings season kicks off, pay close attention to what companies
are saying about their foreign operations. If Europe is really
delivering a blow, then you'll need to quickly assess your holdings
to identify potential European exposure -- you may not want to wait
until your holdings come out with a dismal
2. Watch the balance sheets
One of the biggest concerns in an economic slowdown is rising
inventories and rising
. Companies need to plan ahead and build
in anticipation of future demand, and if inventories sharply spike
quarter-to-quarter as a result of an unexpected slowdown in sales,
then chances are profit-sapping markdowns are coming to move the
goods. This typically applies to retailers, but may also be a
concern for industrial firms like
In a similar vein, rising accounts receivable as a percentage of
quarterly sales can be a huge red flag. This would be an early
warning sign that some delinquent customers simply can't pay their
bills, and those sales will need to eventually be written off.
Companies rarely discuss their balance sheets in quarterly press
releases, so you'll have to listen to the conference calls to hear
the real truth about what is happening with these key
3. All eyes on the banks
For much of the summer, bank stocks have been taking a beating.
Investors have grown concerned that banks such as
Morgan Stanley (NYSE:
JP Morgan (NYSE:
have a significant exposure to the Greek economy, and if the
country defaults on its
, then U.S. banks will need to take significant write-downs. In
response, industry executives such as Citigroup's Vikram Pandit
have issued vague statements that exposure to Europe in general --
and Greece in particular -- is a lot less than many fear.
The banks will need to do better. If their stocks are to trade back
, then investors will need to be provided with a lot more detail
about how any European write-downs may influence book value. On the
coming conference calls, listen closely for a discussion of Europe.
If exposure is as limited as these banks have been saying, then a
powerful sector rally could ensue.
More broadly, the market simply can't sustain any sort of broader
rally unless bank stocks are participating. A flailing bank sector
is a serious symbolic headwind for investors who fret about the
broader health of the U.S. and global economies. So you'll need to
see an "all-clear" from the banks before aggressively buying other
sectors you may have been eyeing.
4. "It's (still) the economy, stupid"
No matter how good corporate
-- and outlooks -- may prove to be, the economy still needs to do
its part. Friday's jobs report (Oct. 7), where 103,000 jobs were
created (137,000 when shrinkage in government employment is backed
out) was surely a positive data point. Last week also saw decent
readings from the ISM's monthly surveys of the manufacturing and
service sectors. As along as these types of reports don't
deteriorate and spook the markets, earnings results -- and outlooks
-- can set the tone for the market in October and into the winter.
Action to Take -->
A key reason for the market's deep slump these past weeks is a lack
of any positive catalysts. Many stocks are now quite cheap and this
week's positive trading sessions highlight the fact that
bottom-fishers are starting to wade back in. For the rest of the
crowd, a still-robust
outlook from corporate America may be the
to get stocks moving.
-- David Sterman
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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