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Earnings Season Is Upon Us

In recent posts, I’ve told you that earnings season will determine if the stock market breaks up or down from our trading range:

sp-500-boxed

As you can see, we have rallied up about half-way from the bottom of the trading range identified by the green box on the chart. We rallied in anticipation of good earnings, but there is not a crystal ball. There is, however, two indicators I follow that have led me to say to you that we MAY have seen the lows in the market for the year (subject of course to all the many issues that could raise their ugly heads).

The big thing that weighed on the market since April was the impending bankruptcy of Europe. All over the media we heard that Europe was imploding and that the Euro would crash, causing a second financial system meltdown much like we had in late 2007 when Lehman Brothers failed. I have written on the blog many times that the indicator I follow of systemic risk, the Ted Spread, just was not showing the same level of risk as it did immediately before and then during the market crash.

ted-spread

You can see that current levels on the indicator are consistent with historic averages prior to the subprime crisis and the stock market crash. Longtime readers will recall that when this indicator moved up in the Spring of 2007, I let you know that we were getting out of all financial industry stocks at that point since the indicator was telling us that there was something fishy in the financial system. That turned out to be a good move. However, we do not have the same reading today, so the financial system is not in the same state that it was in 2007. That is very positive for the future of equity investors – removing the uncertainty surrounding the European financial system means that investors should feel more optimistic about the future and increase the amounts they are willing to pay for future earnings (ie., P/E ratios should expand).

Additionally, if the European financial system is healthier than assumed, maybe corporate earnings will be positively impacted by increased business from Europe. To check this out, I like to follow a shipping indicator that shows goods being shipped across the Atlantic.

Harpex Shipping Index

You can see that the Harpex Shipping Index has turned decidedly up, indicating that business activity in Europe has increased. If business has increased, then corporate earnings of US companies that do business in Europe should also increase, yielding positive earnings surprises when the earnings season begins.

Based upon these two pieces of data, I think we will see earnings surprises and expanding P/E ratios that will drive us upward out of the trading range (green box) toward the level where we’ll likely pause and move sideways in a new trading range (the pink box). At that point, we’ll make a decision on whether to raise some cash or to move additional cash into the market.

Be sure to check back next week as earnings season gets underway and I’ll keep you up-to-date on what whether we will be retuning to the safety of cash and short-term fixed income investments sooner than expected or whether equity investments will likely dance their way toward the new trading range.

Never a dull moment 🙂

Note: this video is for my friend Jon who works for FoxTV and is a big Glee fan.

Mark