The Bullish Test Comes As Earnings Season Begins

Authored by Lance Roberts via RealInvestmentAdvice.com,

A Breakout Of Consolidation

Over the last few week’s we have noted the continuing consolidation of the market since the June peak.  When markets are overbought short-term, that condition is resolved through a correction or consolidation process. Such is what occurred during the last part of June and completed last week.

As shown below, the market broke out of that consolidation and triggered a “buy signals” across multiple measures. This breakout will give the “bulls” an advantage in the short-term with a retest of the June highs becoming highly probable.

The bulls will also gain some additional support from the “Golden Cross” (when the 50-dma crosses above the 200-dma). That “bullish signal” will likely occur over the next week or two depending on market action.

The “bullish supports” for the market are currently in play. Such keeps our portfolio allocations weighted towards equity risk. However, there are many fundamental and economic headwinds that could quickly derail the bullish thesis.

Seasonality In Play

In the short-term, the bulls remain in charge currently, and as such, we must be mindful of those trends. Also, the month of July tends to be one of the better performing months of the year.

As noted last week:

“With the sell-off on Friday, the short-term oversold condition, a reflexive rally next week would not be surprising.”

That rally reversed much of the short-term oversold condition. While the bulls are in control of the market currently, the upside is somewhat limited. However, the downside risks are reduced with the improvement in the technical underpinnings. Such puts the risk/reward dynamics to a more equally balanced, than opportunistic, positioning. As such, risk controls and hedges should remain for now.

• -1.4% to breakout level vs. +2.4% previous rally peak. (Neutral)

• -5% to 50/200 dma support vs. +4.9% to January peak (Neutral)

• -7% to previous consolidation peak vs. +6.5% to all-time highs. (Neutral)

• -13.4% to previous consolidation lows vs. +6.5% to all-time highs. (Negative)

Earnings Estimates Update

Over the next two weeks, we will enter the earnings season for all publicly traded corporations. Of course, we will mostly hear about those companies which comprise the S&P 500 index. I am writing a more comprehensive report on the earnings estimates for Tuesday’s “Technically Speaking.” Still, I did want to make a quick comment about what is coming.

As with every quarter, we are about to play “Millennial Soccer.” Such is where Wall Street analysts continually lower earnings estimates for the quarter until companies can beat them. When you see the analysis that 70% of companies beat their estimates, just remember analysts lowered the bar to a point where “everybody gets a trophy.” 

What will be important to pay attention to is “revenue,” which happens at the top of the income statement. Companies can do a lot to fudge bottom-line earnings by using accruals, “cookie jar” reserves, share buybacks, and a variety of other accounting gimmicks. It is much more difficult to manipulate revenue.

However, the market will focus on reported earnings. As stated, the estimates have fallen sharply over recent weeks, and are far lower than where they were set previously.

Importantly, while Wall Street has dramatically lowered estimates for the coming quarter, expectations remain for a rapid recovery in the economy. Given the rise in COVID-19 cases as of late, states pausing reopening, and depressionary levels of unemployment, it is highly likely those future estimates will ratchet sharply lower.

Such makes the mantra of using 24-month estimates to justify paying exceedingly high valuations today even riskier.

“Price is what you pay, value is what you get.” – Warren Buffett

A Quick Note On The Jobs Report

While the BLS reported a massive 4.8 million in employment for June and a drop in the unemployment rate to 11.1%, these numbers remain distorted by bad data gathering and analysis.

As Mish Shedlock noted on Thursday:

“I question both the strength of the rise in jobs and the decline in the unemployment rate based on claims data and the reference week.”

I agree.

It’s hard to reconcile a 4.8 million increase in jobs in a month where you added over 4-million to initial jobless claims and continuing claims continued to remain near the highest levels on record.

More importantly, as noted by Zerohedge, there is a problem in the data when you have more people getting unemployment benefits than there are unemployed workers.

“As the DOL reported today, there were 19.29 million workers receiving unemployment insurance. And yet, somehow, at the same time, the BLS also represented that the total number of unemployed workers is, drumroll, 17.75 million.

If you said this makes no sense, and pointed out that the unemployment insurance number has to be smaller than the total unemployed number, you are right. And indeed, for 50 years of data, that was precisely the case.”

The main point here is that employment is what drives earnings, corporate profits, and GDP. Given the exceedingly high level of unemployment, in real terms, the recovery to earnings will much slower than expected.

Such suggests that expectations for the bull market to continue “to infinity and beyond,” will likely prove disappointing.