With nothing major on the domestic economic calendar, stocks will likely struggle for direction in today’s trading action. But the overall tone appears to be on the soft side as weak readings from Germany and China bring global growth concerns investors center stage.
A private sector survey of business conditions in China, modeled along the lines of the Fed’s Beige Book, showed business sentiment continuing to weaken despite the Chinese leadership’s efforts to stem the tide. This provides further confirmation of what we saw from the HSBC and Markit PMI readings last week that showed the country’s factory sector in contractionary territory. Germany’s Ifo business climate index for September also came in lower than expected this morning, the fifth straight month of decline. With weakness in manufacturing, retail, wholesale, and construction, the declines are broad-based in the German economy.
This weak international backdrop has had little effect on investor sentiment lately as the market’s impressive gains of recent months shows. Hopes that central bank actions will turn around the economic fortunes have been the key driver of market gains thus far, though many of us have been skeptical of this notion. My sense is the upcoming third quarter earnings season will provide the much needed reality check for this market.
Granted, the earnings picture has not been exactly stellar for a while now – with estimates steadily coming down and growth rates decelerating. Also, it is not unusual for markets to make gains at times while the earnings picture is so-so, particularly if the equity risk premium is coming down as has been the case lately. But the two have to eventually converge – markets don’t go up forever while the earnings picture is weakening. With total earnings expected to be down 3.4% in the third quarter, expectations may be fairly reasonable for the coming reporting season. But estimates for the fourth quarter and next year are on the high side and will most likely move lower once management teams provide more color on the third quarter earnings calls. I am of the view that the market will find it hard to hold on to the recent gains in that backdrop.
But while the overall earnings picture is less than reassuring, the homebuilder space appears to have turned the corner. Lennar (LEN) came out with better than expected results this morning, with new orders increasing 44% and order backlog growing 79% from the same period last year. Lennar is undoubtedly one of the strongest players in the homebuilding space, but we are seeing positive momentum in all industry players as conditions continue to stabilize. The growing optimism for the sector is rubbing off on related industry players as well, as Thursday’s very successful IPO of real-estate information company Trulia (TRLA) confirmed. Unfortunately, homeuilders' small weightage in the aggregate earnings numbers (they will contribute less than 0.3% of the S&P 500 earnings this year) makes the group's positive earnings momentum largely irrelevant.
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