What to Watch As Earnings Season Gets Underway

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I don’t know about you, but I am getting a little tired of violent swings in the stock market based on headlines. With a bit of luck, this week will be the beginning of a month or so when traders and investors will be primarily concerned with economic realities, not geopolitics or “news” about China/U.S. trade. While both of those things matter, the most likely determinant of direction for the next few months is what we will learn about earnings over the next few weeks.

Stocks are trading above the long-term averages in terms of both trailing and forward earnings multiples, so will be sensitive to any weakness, real or perceived. Or, rather, they should be sensitive to that. If this period of news related volatility has taught us anything, it is that the default direction of the market is upward. If stocks can shrug off a very real threat of a shooting war with Iran in a day or so, then this bull market can probably survive anything.

For that reason, earnings would have to be pretty bad to produce a negative reaction, but a positive could be achieved on even a slight beat, especially if it comes in certain areas.

Energy has been the worst performing sector in the S&P 200 for the last decade. Fears of weaker than anticipated global growth have been persistent, keeping oil prices from reaching the heady levels seen before the recession and stocks in the sector depressed. Similarly, manufacturing has underperformed as that sector has been hit hardest by the trade war.

It wouldn’t take much of a beat in either of those areas to spark general buying, as the best chance of a significant move up in the averages from here is if the laggards begin to catch up. The best performing sectors, such as tech (+49% 1 Year) are beginning to look fully valued at the very least, but energy, the only sector that was negative overall in the last year, and industrials that put on less than half that, could easily expand their multiples. Other sectors, such as transportation, which underperformed most of last year and healthcare, which also lagged should also be watched.

So, while the focus of many will be on the big banks that report this week, more information about the direction of the major indices may be gleaned elsewhere. Tomorrow, for example, JP Morgan (JPM), Wells Fargo (WFC) and Citi (C) will grab the headlines, but the performance of Delta Air Lines (DAL) will actually give a better clue as to what to expect as earnings season progresses.

Then, on Wednesday, Bank of America (BAC) will be closely followed and endlessly dissected, but Alcoa (AA) and the little-known PAM Transportation (PTSI) are more worthy of attention. And Kinder Morgan (KMI), who build and operate oil and gas pipelines, will be the first energy related earnings seen this season.

United Healthcare (UNH) also report Wednesday, but in their case the market reaction to their earnings will be more significant than the Q4 results themselves. In the second half of last year UNH, along with healthcare stocks generally, did well despite the obvious threats to the sector from the upcoming election. It will be interesting to see if that optimism remains and the response UNH’s earnings will give us our first clue. Should the numbers be decent, but the response tepid or even a seemingly mystifying drop come on a beat, the whole sector should be treated with care.

Q4 earnings are always significant in some ways. They are pivotal for retail and other consumer-facing businesses, for example. This year though, given the delicate balance inherent in stock valuations they will be more important that usual, but not in areas that you might think. If stocks are to have a good start to the year, last year’s underperformers such as energy, transportation and healthcare will have to show signs of a renaissance, so that is where investors’ focus should be.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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