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Reporting of company earnings to set market direction this week

Mr Kaplan acknowledges that the Fed and markets are locked in an "echo chamber".


US STOCKS last week suffered their biggest losses since the early-year rout because of renewed confusion over the path of interest rates.

This week however, marks the official start to earnings season, and if profit growth can surpass modest expectations, major indexes could resume their march to record highs.

Last Thursday, Federal Reserve chair Janet Yellen emphasised that the US economy was "solid", hinting that the "pause" that the central bank took in its rate hiking cycle, which began in December and has since been on hiatus, may be soon over.

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Despite this, William Dudley, president of the influential Fed Bank of New York, spoke a short time after Ms Yellen and sounded as if he was loath to raise rates, advocating that the central bank stay "cautious" with its policy.

Some central bankers freely admitted that the Fed is facing a quandary. At a recent appearance, Robert Kaplan, president of the Federal Reserve Bank of Dallas, acknowledged that the Fed and markets are locked in an "echo chamber".

Whenever Ms Yellen or another official hints at a change in policy, markets react violently; those violent reactions have real world effects, often causing credit scarcity for corporations and emerging market governments who depend on bond markets.

Moreover, those "bouts of financial tightening" can eventually force the central bank to change plans again, Mr Kaplan acknowledged. That's why, he said, the coming five years when the Fed is "normalising" policy will be just as challenging as the years of recession and financial crisis that preceded them.

"Within a nanosecond of uttering even the most remotely hawkish words, the US dollar rises," said Quincy Krosby, market strategist at Prudential Financial. "It happens almost instantaneously . . . you start seeing tightening of (financial) conditions, commodities under pressure, and sets off chain reactions which makes the Fed say it can't raise rates now."

US corporations are, by now, adept at the "expectations game", and expectations are very low for the first quarter. Aggregate Wall Street analyst estimates forecast that the earnings of the Standard & Poor's 500 companies will register a 7.6 per cent fall, according to Thomson Reuters.

"Not surprisingly, the majority of this is due to a huge drop in energy earnings, with consumer discretionary expected to show nice growth," said one money manager, who couldn't be named because of his firm's policy.

Alcoa's earnings report on Monday is the traditional kick-off to earnings season. The aluminium giant is at the eye of the commodities storm and will likely report another slide in profit, based on prices of the raw material. With all the pessimism about commodities, however, even the slightest glimmer of hope in the outlook for industrial metals demand could cause a rally.

Thomson Reuters analysts say some companies report earnings even earlier than the aluminium giant. The early reporters fly under the market's radar, but Thomson Reuters research suggests their fortunes may have predictive value.

"So far this quarter, 22 companies have reported their first quarter results. Of these, 86 per cent exceeded consensus earnings per share estimates, well above the long term average beat rate of 67 per cent and the average over the last four quarters," said the Thomson Reuters analysts.

The prices of aluminium and other industrial commodities have, in part, tracked the price of the most important global commodity - oil. This year, oil futures have swung erratically between around US$30 and US$45 a barrel, based on the market's impressions of when a glut will finally start to clear.

Mr Kaplan said that his branch of the bank has conducted research on inventory cycles and has concluded that equilibrium will be met some time in 2017.

The price of oil is far more difficult to predict, said Eric Marshall, portfolio manager at Dallas mutual fund firm Hodges Capital.

"One old oilman told me recently you could predict price or you could predict the timing but you just can't predict both," said Mr Marshall. Investors who buy into oil companies at a time of depressed prices should "focus on good companies . . . with good management teams, quality assets and have businesses that you don't have to be perfectly right on the timing".

For now, Mr Marshall, Mr Kaplan and others are optimistic that the positives from lower oil prices and a stronger US dollar will outweigh the negative effects on the US economy. But rate phobia could sweep through global markets again as it did in January and February, darkening the outlook for both the economy and US stocks.

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