Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

Vulnerability Abounds

Earnings season may have reached its pinnacle of influence over the markets this week, as the momentum-based rally in stocks began to fade. With close to 200 companies reporting thus far, earnings are up 10.8%, but revenues are up only 3.1%. Of those reporting, 54% have beat revenue estimates, the rest having fallen short. The results appear to be a repeat of the second quarter, if not for the exception of financial sector disappointments and a growing uncertainty as we move into the 4th quarter.

13, 10-25, Box ScoresThe markets have thrown caution to the wind, deeming all problems solved by simple increases in the federal debt and extensions of QE. It may surprise speculators to know that higher rates and a plummeting dollar are on track to spoil those theories. With the exception of the Dow, stocks reached new highs this week – if only by a thin margin. Treasuries enjoyed modest gains on the promise of QE, while the dollar fell and gold rose. Financial and semiconductor sectors were the only laggards among stocks during the week (see the box scores).

Overseas, a rebound in China’s manufacturing PMI surveys were largely offset by a lack of PBoC support for cash markets (in response to an overheating housing market), and a drop in German business and eurozone manufacturing (also PMI) confidence. Disappointments at 3rd quarter earnings and forecasts both in Japan and in Europe had overseas stocks and selective bond markets (i.e., Italy) softening by weeks end. Mario Draghi’s pledge to hold euro banks to strict standards on leverage ratios also contributed to the caution in stocks.

Financial firms may not act on an overdue profit-taking spree in stocks until after month-end in October, and may look for excuses to game stocks higher moving into November and December. However, outside the promise of QE – which may not be as effective as it once was in controlling rates, stock bulls may face more risks ahead than expected. Budget talks in Washington have been replaced with a quick, no-limit debt fix; job creation (148,000 non-farm payroll for September) is below par; and the dollar looks set to free-fall – as it did before the crash (Black Monday) in October of 1987.

Gold found major support in mid-October near $1,275 on the chart, around the same time the US Dollar Index established a new home below the 80.0 mark, a relationship previously discussed here at length. From that support level, gold has managed a modest breakout above a near-term bearish trend (in place since late August). To confirm the move, we would like to see gold pursue levels above 1,400. Fuel for that rise will rest primarily on US economic data. If it continues to underwhelm as it has, the dollar will likely slip further, yielding a long-awaited rally in gold that will be hard to impugn.

Best regards,

David Burgess
VP Investment Management