Earnings season has done a number on equities, as it should, but does this set us up for a strong third quarter?
Earnings Disappoint
As earnings season is fully underway we find the S&P hovering at 3.35% year to date and Dow Jones at 0.71% year to date at weeks end[1]. Obviously issues internationally, such as Greece and China have caused some fear as well, however earnings season has given no cause for a market resurgence.
With over 70% of S&P 500 companies reporting earnings, 73% beat earnings and 52% have beat revenue[2]. This signals a stronger percentage of companies meeting earnings through cost cutting initiatives rather than through sales.
This could be setting up a strong third quarter as consumers have indicated intent to spend more on the back to school season and lowered expectations from corporate guidance during the second quarter.
Doves becoming Hawks?
Janet Yellen chair of the Federal Reserve Board (FRB) has been labeled a dove repeatedly. It has been assumed that the FRB will not move rates until jobs reports make it well below normalized unemployment. While the FRB does have an employment mandate it has to be remembered that we are currently at a 0% interest rate. A FRB move to increase rates to .25% to .50% does not tighten monetary policy but rather make a move towards normalizing rate policy over the next several years.
Why is it important the FRB normalize rates when economic activity is still soft? By normalizing rates slowly they provide themselves with a monetary tool to combat a recession should one occur. If the US were to slip into a recessionary environment today the FRB would strictly have quantitative easing measures they could implement. Those measures balloon the balance sheet at the Federal Reserve. By raising rates they enable their traditional activity of lowering rates when needed later.
Consensus opinions are that the FRB intends to raise rates at either their September or December meetings. It is likely to be the September meeting as opposed to the December meeting.
The likely effect of a rate hike would be less consumer spending. You would want the impact to be muted by a more robust spending season, such as the 4th quarter. If they raise rates in September the typically robust holiday buying season would likely mute the impact of the rate hike. Where as a hike in December would lead into a typically soft economic first quarter, where spending is typically down.
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[1] www.jpmorganfunds.com – weekly market recap
[2] www.factset.com – earnings insight