nyse board

If the action seen over past couple weeks has told us anything, it is that (a) the worries over global growth have dissipated and (b) there appears to be some trepidation over the state of the current earnings season.

The first part of this analysis explains why stocks have blasted higher since the end of September (to the tune of +7.2% in just 9 days). Sure, short-covering probably had a LOT to do with the initial move – especially after the “retest” of the August low turned out to be successful. And according to BlackRock, investors were also excited about the Trans-Pacific Partnership as anything that will help global growth looks like it is being welcomed with open arms at this stage of the game.

However, just about the time traders dressed in their bull costumes began to break into a rousing chorus of “Happy Days Are Here Again,” the short-covering/oil-induced rally suddenly stalled. And given that the bulls have tried but failed to break on through to the other side of the 2020 area on the S&P 500 for three consecutive sessions (with yesterday’s action being particularly disappointing), it would appear that there is now a clear line of resistance.

The chart below marks the lines in the sand that each team has to deal with.

S&P 500 – Daily

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I will posit that the sudden loss of momentum seen over the past 3 days coincides with the start of the meat of the Q3 earnings parade. And with stocks positioned very close to what is now an important line in the sand (i.e. the resistance zone at 2020), it is highly likely that the quarterly results from the big names in the S&P will be the catalyst for the next important move – in one direction or the other.

Here’s What We Know

So, with earnings looking to be the pivotal data in the next couple of weeks, it is probably a good idea to have an understanding of what traders are looking for.

First, recognize that expectations for earnings growth – or more appropriately, the lack thereof – have been falling hard for a couple months now. It wasn’t that long ago that analysts were looking for combined earnings on the S&P 500 to be down 1% on a year-over-year basis in Q3. However, fast-forward to this week and analysts are now expecting to see earnings fall by 5.1%.

Next, we should note that much of the anticipated decline in earnings can be blamed on one area – the oil patch. But according to FactSet, if one looks beyond the energy sector, earnings are expected to come in flat at best. So, we can’t simply blame all the bad news on oil.

Then there is the greenback. Assuming that the trend from last quarter continues (and it certainly has in the reports so far), there will be no shortage of CFO’s blaming their shortfalls on “currency headwinds.” So, in addition to oil, we will want to see how much blame the dollar takes this quarter.

In addition to declines in earnings, analysts now project that revenues will also experience a decline during the quarter. Remember that while EPS (earnings per share) are easily “manufactured” these days, revenues are much harder to fudge. Thus, watching the revenue results will continue to be important in the coming weeks.

And finally, we should remember that earnings also declined in the second quarter. So, if Q3 results come in as anticipated, it will mean that earnings will experience their first back-to-back quarterly decline since 2009.

The Bottom Line

The key here is to recognize that none of the above is new. It’s simply the degree of the earnings shortfall that is now in question. Therefore, traders will be very interested to see if Wall Street analysts, who, for the record, rarely get their earnings projections even close to reality, have overdone it to the downside yet.

So, if the earnings season winds up being “not as bad as expected,” we would not be surprised to see stocks rally a bit.

However, on the flipside, if the season is weaker than the street is looking for, disappointment might be the order of the day and some additional “price discovery” to the downside can be expected.

Then again, if reading earnings reports is not your thing, one can always just watch the lines in the sand. For in this business, the reason behind the move isn’t always terribly important. No, it’s getting the move right that matters.