Earnings Season
This is the Group I am Watching Closely
Stocks moved higher yesterday with the growth and momentum names leading the charge. Why? Covid case counts are moving higher around the world so the knee jerk reaction is buy what worked in the spring and early summer. Names like Peloton, Pinterest and Amazon all traded well. Apple added more than 6% on the day. They are going to release a new lines of 5G phones today along with new AirPods and a new HomePod. Amazon kicks off Prime Day today. These are events that have been on the radar for a while for both companies so I have to wonder if there is more to the strength.
It is hard for me to think that there is much will, political or otherwise, for us to go back into a lockdown in the US. So it seems that more of the same will be seen as a benefit for the past winners, it’s hard to argue there. It also lines up with my view that there is little to no growth globally, so owning the companies that are growing is probably still a good bet. But in fairness, the bond market was closed for holiday so I am not going to draw too many hard conclusions.
But, there is no denying that breadth is broadening out. Small cap stocks have broken to the upside and are within striking distance of their highs from earlier this year. So it is not the same as earlier this year when leadership was much more narrow. A healthy majority of stocks in the S&P 500 are in uptrends across time frames, something that I have been highlighting for clients. The A / D Line is also trading at record highs. This is bullish.
The macro has been the key driver to the market for the past few weeks: COVID, Stimulus, Jobless Claims and the NFP Report have been top of mind. Now we move into earnings season. Even with the election fast approaching, there is no getting around the fact that we are going to hear from companies across the market to get a sense of how things are going. At a high level, analysts are looking for an earnings decline of ~21% y / y, for the third quarter. This is going to be an interesting reporting season because many companies are still not giving guidance (some are), but will they get the same “pass” for poor results that they received in the first and second quarters? Probably not. The bar is still extremely low, but companies better exceed expectations (which are moving up given the move higher in stocks over the past three weeks).
This always leads to the questions about what stocks or sectors look good around earnings. I am not going to play the earnings game this quarter, no different than any other quarter. If the story is good and the trend is up, I like it (technology, industrials, discretionary, materials). If the story is bad and the trend is down, I don’t like it (energy). If the story is improving and the trend is losing downside momentum, I sit up and take notice. I watch intently through the reporting season, especially the biggest names in the group. This quarter, that’s the fins. I can’t believe I just wrote that.
Why the fins? And this is not to say that they should be owned, simply that they may be at an inflection point for a trend change right in front of a catalyst. The group has been a big underperformer, especially the banks which made a relative low last week that was not confirmed by momentum.
The problems in the economy are well understood, that’s why the next round of stimulus is so important. The question is, are the banks ready for the environment to remains slow? Here is the allowance for credit losses that was posted in the Wall Street Journal, it seems that they are.
Here is what the team at Morningstar had to say about provisions:
While banks have had elevated loan-loss provisions year to date, loan charge-offs have remained muted. If heightened government stimulus doesn’t continue, we expect charge-offs to substantially increase, as unemployment remains high. That said, we believe that banks have enough capital to survive these medium-term negatives and that they can be suitable for long-term investors.
One of the biggest issues for the banks has been the low level interest rates, the old 3 , 6, 3 model is long gone…"Borrow at 3%, Lend at 6%, Golf Course by 3pm.” Here is the average NIM from the same article:
Morningstar on rates:
Interest rates will likely stay low for an extended period. According to the U.S. Federal Open Market Committee’s dot plot from September 2020, most members believe the federal-funds rate should stay in the 0% to 0.25% range through 2023.
But, there is scope for improvement. The yield curve as been steepening through the quarter, good for a business that borrow short-term and lend long-term, in general. If the prospects for more stimulus keep this steepening in place, there is hope that the banks can reverse this trend in the NIM and aid profitability. This would be a positive catalyst even if from depressed levels.
None of this is to say that I like the banks right now. I do like the idea of paying a close watch to the group for signs that the fundamentals improved to the point that the trends begin to reverse to upside. I still see this as a better group to watch for a turn in the near-term than the beaten down energy space.
These are my high level thoughts, I write a more in-depth analysis every trading day for Chaikin Analytics clients. Click the link below for more information on how you can sign up for a trial.