Money

Reading Tea Leaves as Risk and Uncertainty Return

The last few weeks have gotten a little rocky for the S&P 500 with the index climbing 1% or so since July 15. That’s about the time that corporate earnings kicked into high gear. While the second quarter’s results have been on par with recent quarters, the slowing earnings growth outlook and other factors are starting to weigh on the market. The latest weekly data from FactSet shows that 80% of the S&P 500 companies that have issued earnings per share (EPS) guidance for the third quarter issued negative EPS guidance. While that percentage is essentially unchanged from the March quarter, it is well above the five-year average of 62%.

Taking a cue from history, investors don’t pay up for companies that are delivering slower earnings growth. Investors rather tend to dump those companies that have a more favorable growth to valuation tradeoff or rotate into companies whose business models are far more inelastic in nature. Examples of the latter include makers of non-discretionary items, such as paper products and healthcare, as well as sin or guilty pleasure stocks that produce alcohol, tobacco, chocolate and similar kinds of products.

In addition to the slower earnings growth outlook, there are other concerns weighing on the stock market and investors’ minds. One that is back on the table is whether or not the Federal Reserve will taper its efforts to stimulate the economy before too long. We can thank Richard Fisher, president of the Federal Reserve Bank of Dallas, for reviving that conversation when he reiterated late Thursday that the central bank probably will begin cutting back on its massive bond-buying stimulus next month, as long as economic data continues to improve. While the start of this week is slower than it has been in recent weeks, we will be getting a hefty slug of manufacturing and housing data later this week that will test Fed president Fisher’s comments.

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