Is the smart money buying US stocks?

By Ben Turney 

Earnings season apparently went off with a bang earlier this week as Alcoa “beat” Wall Street expectations.  The overjoyed headlines, which followed, were amplified the next day as market commentators went wild at remarks by Ben Bernanke which apparently suggested his “put” is still in place.  The Dow has stuck on 350 points since Monday and stocks are apparently heading for their best week in 8 months.  You’d be mad not to be buying this market wouldn’t you?!

I can’t deny we are one Fed speech away from busting through all time highs, however scratch away at the surface of this latest euphoria and a different picture starts to emerge, which suggests conditions could be about to get tougher for US stocks. 

As I wrote yesterday, I am not buying the market’s view that the taper is off.  ZIRP looks set to continue through to 2015, but an announcement could be made as early as July 31^st that the Fed will start to end its bond purchasing programme in September.  If June’s reaction is anything to go by, this could have a significantly adverse impact on sentiment, but there is another fundamental reason I am not buying this rally.  The earnings’ story is also giving me some cause for concern.

Many will have read this piece by Zerohedge about how Alcoa “beat” expectations.  In summary the consensus forecast for the adjusted earnings per share (EPS) fell over 60% from the start of the quarter to $0.06.  Alcoa’s adjusted earnings came in at $0.07, but this was still a far cry from the $0.16 estimated at the beginning of April.  In fact such was the increasing gloom surrounding this stock it was hard for it not to have beaten the consensus.  A miss would have been disastrous and the headlines massively different.

The first “positive” result has been so well received by the market as it is not just Alcoa which has experienced massive downgrades in expectations over the quarter.  The same has happened across the board.  Apparently a record number of 87 companies in the S&P500 have given negative guidance for their earnings this quarter.  It is no surprise that the table below reflects the extent to which the downward revisions are widespread:

If results come in, in line with expectations then this will be the weakest quarterly growth since 2008.

This being said a weak quarter is not as terrible as it might sound.  Current forecasts are expecting a rebound over the next 4 quarters and stocks are currently trading at a forward P/E of 13.9 against a historical 10-year average forward P/E of 14.1.  The question is will these forecasts be subject to downward revision as well?

Obviously we need to see what the companies have to say about the last quarter’s performance and what guidance they give about future earnings, so it is too early to have a firm opinion.  However it is extremely difficult to see anything other than a negative reaction in financial markets and the wider economy in response to the initial withdrawal of QE.  QE is now so deeply imbedded in the popular consciousness as the supporter of growth that its removal (or even the anticipation of its removal) could prove traumatic. 

And traumatic experiences are hardly conducive to healthy spending behaviour.