Markets: Signal, Noise & Fundamental Factors
After several weeks of dismal performance, equities shook off their worries and rallied enthusiastically on solid quarterly earnings giving the S&P 500 its biggest weekly gain of the year. For the week, the S&P 500 gained 4.12%, the Dow grew 2.59%, and the Nasdaq surged 5.29%, erasing much of their losses from previous weeks.
Last week, we discussed some of the factors behind the recent pullback; what changed in a single week? Fundamentally, very little. However, investors regained their optimism on the reminder that many companies are still doing quite well in the economic recovery. Traders also took the opportunity to buy the dip, which added buying pressure, pushing markets up.
Markets are fundamentally forward-looking, and while global growth fears remain, investors are looking at the earnings growth picture, and realizing that the picture looks reasonably good. Not great, to be sure, but so far, S&P 500 firms are reporting 4.1% year-over-year earnings growth on 4.7% revenue growth, with about 41% of the S&P 500 firms reporting as of October 24. If we leave out the struggling Finance sector, earnings growth jumps to 5.5%. These results are largely in line with performance in recent quarters, though earnings growth is below the four-quarter average, largely because of weak performance in the Finance and Technology sectors. All told: Firms seem to be holding their own and turning profits, despite some weak demand issues.
Does this mean that the pullback is over? Hard to say. Markets are responding more to perception and noise than they are to fundamental factors right now. That means that more turbulence – and perhaps downward movement – can be expected in coming weeks. On the other hand, if earnings and economic fundamentals continue to look good, we may see a continuation of the rally.
Looking ahead, earnings reports from the energy and healthcare sectors will dominate this week; the two sectors represent opposite sides of the market. Healthcare was one of the big success stories of the year, while energy companies have struggled with declining oil prices. While analysts expect weak results from many energy firms, they will be paying close attention to forward guidance; if energy leaders foresee a weak global economic environment, investors could respond with another attack of the nerves.
The week ahead is also heavy in economic data, with the Federal Reserve’s Open Market Committee meeting and a first look at Q3 Gross Domestic Product (GDP). The Fed is widely expected to announce the end of quantitative easing at this week’s meeting; analysts also expect the formal announcement at the end of the meeting to signal a more cautious Fed and their desire to let economic data decide future policy moves.
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