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Will Q2 Earnings Lift or Sink the Market?

Here's a summary of Q2 earnings season thus far: The reports, from the financial sector to utilities (NYSEArca: XLU), absolutely stink.

In fact, negative to positive earnings guidance for S&P companies (NYSEArca: SPY) for Q2 is the worst since the Financial Crisis in 2008.

Before we get into the gory details, let's look at just one of the industry sectors that was supposed to "lead" earnings growth; financials.


The hot performance of financial stocks (NYSEArca: XLF) belies their real life lackluster Q2 earnings results and deeper problems within the sector.

Goldman Sachs ( GS ) reported an 11% fall in second quarter profit and its $16.6 billion of revenue during the first six months are 14% lower from last year. Goldman's corporate earnings declined to their lowest level since 2005. Their return on shareholder equity also declined.

More worrisome, is the lingering habit of financial/banking stocks to blindside shareholders with nasty and unwelcome surprises.

JPMorgan Chase ( JPM ) is dealing with a massive trading loss that could top $6 billion and possibly be as high as $9 billion. JPM posted a 7% decline in profits compared to a year earlier. Question: If a bank posts a one-time loss next quarter in addition to the latest quarter's losses, does that make it a two time loss or a one-time quarterly loss twice?

Bank of America reported Q2 EPS of 0.33 and beat estimates mainly due to a low hurdle compared to a large loss reported for Q2 2011. If we exclude Bank of America, the projected earnings growth rate for the S&P 500 falls from 3% to -1.7%.

What about risk? How are companies within the financial sector doing?

While JP Morgan's lack of risk management prowess has captured the public's attention, what about Citigroup? Citi's net exposure to Greece, Ireland, Italy, Portugal, and Spain was $9.1 billion at the end of the second quarter - up from the previous quarter! Citigroup reported a 12% decline in second quarter earnings.

Slowing Consumers

Here's another problem: Three consecutive months of lower retail sales. June's Retail Sales Report (NYSEArca: XRT) showed a -0.5% month-over-month decline following -0.2% in May and another -0.5% in April. Not only do the latest retail sales figures mark the longest streak of MoM sales declines from the July-December 2008 period, but it means that previously cheery GDP estimates will fall.

Gasoline stations suffered the largest sales declines, which is curious. Typically, lower gas prices (NYSEArca: UNG) gives consumers more money to spend, but they aren't spending. If anything, consumers are hunkering down.

Unlike the dot com bust in 2000, the aftermath of the Financial Crisis and the Great Recession has taken a toll. The year-over-year change of 3.8% for retail sales is the weakest since mid-2010. Can the U.S. economy recover without consumers? What about the stock market?

A 'Mean' Reversion to the Mean

The chart below plots the S&P 500 against earnings since 1998. All major market tops coincided with record earnings and Q1 2012 operating earnings established a new peak. On April 2, 2012, the S&P peaked at a closing high of 1,419.

Earnings projections for the remainder of 2012 are around $105 and 2013 expectations are a rosy $119. The chart shows the direction of earnings projections at previous highs or lows. Analysts did not see any of the mean reversions coming (just like now), but mean reversions are hidden in plain sight.

The ETF Profit Strategy Newsletter visually and statistically illustrates the massive risks associated with owning stocks when earnings have peaked and when the global economic environment is worsening.

It's important to view the recent market action in combination with technical indicators. The Fed has been able to "game" fundamental market forecasting, but not technical indicators. One of those indicators is support/resistance levels.

Once stocksbreak below key support levels they tend to drop much further as selling creates panic (like in 2010, 2011 - imagine a person walking on thin ice; once the ice breaks, the fall happens quickly.)

The ETF Profit Strategy Newsletter pinpoints the key support level - that once broken - will be a sell signal and likely lead to much lower prices.

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

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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