David Joy: This earnings season will matter

While Portugal’s Banco Espírito Santo scare may have provided a convenient scapegoat for the market’s temporary wobble last week, the reality is that it likely had little to do with U.S. stocks shedding 0.9%, their worst performance since early April.

More likely, last week’s selloff had more to do with investors returning from the long holiday weekend and taking another look at the strength of the June jobs report and reassessing its impact on the pace of future Fed policy. There were also likely some jitters ahead of the start of second quarter earnings season. With valuations and sentiment elevated, the role of earnings becomes even more important in supporting equity prices.

Financials headline the roster of big name earnings reports this week, beginning with Citigroup on Monday, followed throughout the week by Goldman Sachs, JP Morgan Chase, Bank of America and Morgan Stanley. It is likely that revenue from trading activity, particularly in fixed income, will once again be a drag on the quarter’s performance, offset to some extent by a rise in lending activity.

According to Factset, financials as a whole are expected to post the worst earnings growth of any of the S&P 500’s ten sectors in the second quarter, down 3.9% compared to last year. It is the only sector where earnings are expected to decline. Overall, earnings are expected to grow by 4.6%, led by a 20.9% rise in telecom, followed by an 8.9% gain in consumer discretionary.

In addition to earnings, this week’s economic calendar is full of potentially market-moving data releases. Especially important will be Tuesday’s release of June retail sales. Recently soft personal consumption numbers have raised questions about the health of the consumer sector, an essential component of any sustained expansion. Consensus estimates expect something of a rebound from a tepid rise in May. Later in the week, industrial production, the National Association of Homebuilders index, housing starts, building permits, consumer confidence, leading indicators, and the Philly Fed index are scheduled.

Yellen goes before Congress
Also ahead this week is Fed Chair Yellen’s scheduled testimony before Congress. The hawks at the Fed have gotten a little louder lately with inflation beginning to rise and unemployment falling faster than expected. Yellen has insisted that there remain significant signs of weakness in the labor market and that there is some noise in the recent price data, all suggesting little urgency to accelerate Fed policy.

In fact, commodity prices, especially for energy and agricultural products, have fallen sharply in the past few weeks. Estimates of record harvests have pushed the price of corn and wheat sharply lower, while oil prices have fallen on receding fears of potential supply disruptions in the Middle East. Last week’s release of the minutes from the June FOMC meeting revealed the Fed’s intention to end QE3 in October. Given the extent of the Fed’s monetary stimulus, expect a lot of questions about the threat of inflation, the Fed’s exit strategy, and whether it might not already be behind the curve.

Meanwhile, stocks prices seem to want to move higher. They can, if earnings and firm economic data support them, although valuations leave less room for disappointment.

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