“The general who wins the battle makes many calculations in his temple before the battle is fought. The general who loses makes but few calculations beforehand.”—Sun Tzu
Don’t look now, but the Dow could easily end the year about where it started. All it will take is another few rounds of weaker-than-expected earnings reports to seal the deal, accompanied by a resultant move downward of about 7% for the Blue-Chip index.
Could this realistically happen, or is the current October sell-off more in line with a three-month sideways trend, albeit with a high level of volatility?
Looking at last week’s market action, it seems as if the current wave of investor sentiment is leaning towards a downtrend, a definite shift from the uptrend that has been in place since early June. Evidence would point to the reaction of investors to a combination of both positive and negative economic news that appeared on the radar last week. A more Bullish sentiment probably would have resulted in a collective shrugging off of the bad and a focus on the good.
However, that just didn’t happen.
All three of the major indexes ended in the red last week, and technically speaking, the uptrend in place since June has been broken for both the Dow Jones Industrial Average (DJIA) and the S&P 500 Index (SPX). On the week, DJIA shed 1.8%, the SPX lost 1.5% and the Nasdaq Composite (COMP) dropped 0.6%.
In spite of positive economic data from several sources, including better than expected GDP numbers and improved consumer sentiment readings, investors seemed to focus on poor earnings and revenue-growth projections, notably those of Apple and Amazon.
Specifically, the Commerce Department reported that the GDP increased by 2% during the last quarter, which was slightly better than a number of economists had anticipated. In addition, the most recent consumer sentiment reading, as indicated by the University of Michigan/Thompson Reuters index, hit its highest level in about five years. Taken together, the data could easily support a narrative of slow but steady progress on the domestic economic front.
But that was not the narrative that Wall Street was reading last week.
Instead, it could be argued that earnings reports are being viewed simultaneously as both a lagging and leading indicator. So, besides confirming that the economy has continued to shake off the effects of the recent recession at a disappointing clip, the expectations of an improving economy could be limited, a perspective reflected by the weak corporate earnings projections presented by a number of corporations last week.
Which leads to another issue, one that is something of a conundrum.
Corporations are now sitting on historically record amounts of cash. Based on a recent report by J.P. Morgan, the S&P 500 now has a collective storehouse of nearly $1.5 trillion, the highest amount on record. This is occurring, according to several surveys, due to the degree of uncertainty that companies have because of several key factors, including poor global PMI data and the looming fiscal cliff.
One predictable outcome of this continued lack of certainty is that management will remain hesitant to commit to more hiring and increased levels of R&D, at least until such issues as tax rates and the composition of the next Congress has been clearly established.
Because of this, the unemployment rate may rise, ending up reversing recent gains in the jobs market. Should this happen in large enough volume, and for an extended period, consumer sentiment could also shift backwards, and companies could find demand for their goods seriously impacted.
So, to a certain degree, the current round of cash hoarding by corporations, as protection against a weakening economy, could become a self-fulfilling prophecy.
It will likely take a combination of events to offset any additional disappointing earnings reports, including a level of solidarity among the Eurozone members, encouraging economic data on the domestic front, and election results that indicate, in one direction or another, that the logjam that is currently en vogue in Washington will be broken and workable solutions become the order of the day.
In lieu of that somewhat unlikely trifecta of positive indications on both the national and international economic picture, a string of encouraging earnings reports could also stem the tide of the recent weak performance by Wall Street.
A muddle of both possibilities will likely continue a similar choppy version of sideways that the market has been experiencing for these last several weeks.
Strap on the seatbelts, sit back and prepare for this week’s bumpy resolution to the month of October. It will inevitably set the tone for how the year plays out in terms of landing on red or black.
ETF Periscope
Full disclosure: The author does not personally hold any of the ETFs mentioned in this week’s “What the Periscope Sees.”
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