Surging equities at risk ahead of earnings season

16 January, 2017

Friday the 13th has proven to be not-so-unlucky for the equity markets, as stocks surged early in the day at the outset of earnings season. Several major financial institutions reported earnings before the US market open. On balance, the news was good, easily beating estimates in several cases. And although Wells Fargo missed forecasts, its shares still surged on the open. JP Morgan Chase, Bank of America, PNC Financial, and BlackRock all reported earnings that were better than consensus estimates.

While earnings season has started on a very positive footing, however, banks and other financial companies were already expected to shine more than others due to rising interest rate expectations. As non-financial companies begin to report in the coming weeks, though, the current Trump Rally will undergo a more extensive test of its staying power.

Despite a good showing for the start of earnings season, US equity indexes continue to meander within a relatively tight range near their recent all-time highs, as has been the case for the past month. This could just represent a consolidation before the next potential leg up. Or, it could be showing a loss of upside momentum as the markets become more cautious amid continuing uncertainties surrounding the incoming Trump Administration. For the S&P 500, the trading range within the past month has been roughly contained between 2280 to the upside and 2240 to the downside. Meanwhile, the much anticipated 20,000 mark has continued to elude the Dow, despite valiant efforts.

Besides the barrage of earnings reports that will likely test the markets in the weeks ahead, next week brings one event that markets have been most eagerly anticipating. Friday, January 20th is the day that Donald Trump will be inaugurated and formally takes office as President of the United States. From that day forward, the many growth-inducing promises that Donald Trump has made, which have helped buoy the markets to new record highs in the past two months, will begin to matter much less than the actual actions taken to fulfill those promises.

Markets are typically prone to rise on lofty expectations and fall on less-than-lofty realities. If the reality under President Trump fails to match expectations with regard to fiscal spending, lower taxes, financial deregulation, or other market-related issues, investors could potentially be in for somewhat of a rude awakening.

This week, we received a bite-sized taste of what could come to be when Trump spoke at his first formal press conference since his election victory. Instead of making any mention of stimulus, taxes, or deregulation, the president-elect was much more concerned with discussing plans to address his conflicts-of-interest, criticizing the media for reporting “fake news,” and condemning pharmaceutical companies for their pricing practices. Market indexes initially dropped as a result, due in part to the hit on the health care sector, but quickly bounced back as broader optimism was not substantially deterred.

As markets navigate through earnings season and the launch of a new US government in the coming weeks, it would be prudent to realize that real risks for the markets continue to loom, despite the fact that these risks are largely being disregarded at the moment. While Inauguration Day in itself is not likely to cause any major market breakouts, the weeks ahead are very likely to bring significantly increased volatility as the incoming administration eases into its new and unfamiliar role. The bar of expectations is high and the challenges to fulfilling those expectations will abound.

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