Is It Complacency? - Ahead of Wall Street

By Zacks | Updated July 30, 2014 AAA

Friday, June 27, 2014

Stock market investors didn’t care much about the ugly Q1 GDP picture, which progressively got worse at each revision, in the hope that the one-off weather-centric restraints in that period will be replaced by a strong rebound in the current and following quarters. This reassuring narrative helped the market continue making gains, pushing the broad indexes into record  territory. Some of that optimism has no doubt been confirmed by positive economic data, indicating a growth rebound in the current period.

But as Thursday’s consumer spending data shows, the magnitude of the Q2 rebound is a lot less robust than consensus market expectations. As a result, estimates for GDP growth have started coming down and the negative revisions trend could gain more momentum in the coming days if data continues to come on the soft side. We will start seeing monthly economic data for June from next week onwards, starting with Tuesday’s ISM survey and Thursday’s June jobs read.

Beyond next week, the Q2 earnings season will take the spotlight. Estimates for Q2 have come down, largely in-line with the negative revisions trend that has been in place for quite some time, with the current expected growth rate of +2.9% down from +5.5% at the start of the quarter. Some of the initial Q2 reports from companies with fiscal quarters ending in May from the likes of Oracle (ORCL), FedEx (FDX),Walgreen (WAG) and others present a mixed picture.

At stake is not so much the actual growth in Q2, which most likely be better than the currently expected +2.9%, but the outlook for the second half of the year and beyond. The consensus expectation is for a material growth ramp up in the second half of the year to +8.5% total earnings growth from the first half’s +2.1% pace. Corporate guidance, which has persistently been on the weak side in recent quarters, will determine whether those expectations will hold or will need to come down. To that end, this morning’s DuPont (DD) pre-announcement could very well be a sign of things to come.

Is it complacent behavior on the part of investors to keep rewarding stocks despite the less than stellar economic and corporate earnings fundamentals? Regular readers know where I stand on that issue, but my sense is that others will start reaching that same conclusion in the not-too-distant future.

Sheraz Mian

Director of Research

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