Earnings season fails to halt recovery

Jan. 18, 2019 – The market continues to show some strength as it recovers from the fourth-quarter of last year. All three major indices posted gains again this week, and the S&P 500 crossed a key technical level at 2,600. 

We also got our first batch of earnings results. We noted in this space last week and Monday’s weekly preview that while the numbers were important, the reaction to the numbers was perhaps more important. In fact, here’s what we said last week:

“This earnings season seems likely to be a mixed bag, with some strong results, and some weak results.  What will be more interesting is the market’s reaction to the reports… In 2016 and 2017, the market seemed willing to overlook any bad news. If there was a way to spin the quarter as positive, stocks were getting bought. That pattern didn’t hold up in 2018 as investors seemed less willing to accentuate the positive and more inclined to focus on the negative. 

“That pattern could continue this time around, with some analysts already talking about the advisability of companies reporting “kitchen sink quarters”, which is the practice of reporting all the bad news you possibly can, so that the next quarter is more likely to be better than expected. If we get a lot of those, we’re likely in for a rough couple of months. However, if results end up being better than expected, stocks could rally, especially given how far valuations on some names have fallen recently.”

So far, it seems like traders are willing to overlook a less than perfect report. The big banks are all ending the week higher than where they started, despite some less-than-perfect earnings reports. Netflix (NFLX) fell after it’s report fell short of expectations, but that came two days after the stock rallied when the company announced a price increase, leaving the streaming giant pretty close to where it started the week. 

Even better, there was no real contagion to other FAANG stocks when Netflix fell, suggesting that traders have, for now at least, moved past the sell first and ask questions later mindset we saw at the end of 2018. Hopefully this trend toward moderate, company-specific responses will continue as earnings continue to roll in. 

There are some other potential issues facing the market going forward. The longer the government shutdown drags on, the more the effects will show up in the economy. Government employees will be paid for the time eventually, but after already missing one paycheck this month and potentially another one next Friday, things are certainly getting pretty tight for a lot of families. That says nothing of the government contractors who are not working and won’t be paid back. There are also lots of service-industry workers being hurt by a lack of spending by those other groups.

There’s also the thorny issue of trade. Those negotiations with China are set to resume, at a higher level this time, at the end of this month. Rumors circulated late this week that the Trump administration could lift tariffs on China as part of a negotiating tactic, but those rumors were quickly squashed. Higher tariffs are set to kick in at the beginning of March under the terms of the agreement President Trump reached in Argentina. As we get closer to that deadline, I would expect the market to react negatively if it looks like those new duties will be enacted.

Indices

All told this week, the S&P gained 3.7%, the Nadsaq rose 3.7%, and the Dow Jones added 3.6%.

S&P 500

Looking at the S&P 500 on a 2-year chart, with weekly candles instead of daily candles, paints an interesting picture. The stock market sold off hard back in January 2016. It quickly recovered and stayed in a steady uptrend all the way through January 2018. This kind of growth and stability made buying-the-dips easy, spoiling many investors with big-gains that were relatively easy to come by. When 2018 treated us to its first wave of heavy selling, it seemed like chaos. Days turned into weeks, weeks turned into months, with huge reversals, gaps and intraday swings really throwing traders for a loop. When the market began to find stability again in the second-quarter of 2018, everyone breathed a big sigh of relief, going back to business as usual.

When the market treated us to its second wave of heavy selling in October, this is where things began to really go off the rails. At first, it seemed like just a repeat of February. With news headlines seemingly becoming the driving force behind every move the market made. When the S&P decisively closed below its 50-week (not days) moving average (red line), it was panic buying and selling all over again, but this time, it was stronger than before, with chart technicals pointing to a bear market. When the heavy selling continued again in December, it was relentless. One of the remaining strong levels of support around 2,600 also converged with the S&P’s 100-week moving average (blue line). When the index closed below this level, it snowballed out of control. It is interesting to see how the 200-week moving average (green line) came into play, giving much needed support to the S&P, allowing it to bounce back to relative safety.

It is also interesting to compare the size of the candles pre-2018 to those during 2018. Those kinds of big moves are very hard to trade with any reliability. Luckily, most of the huge moves were met with equal-and-opposite moves. This past week is what many bullish investors were holding their breath to see. It is a very bullish sign to see the S&P rise back above its 100-week moving average, gaining some much-needed technical support as well. Had the S&P fallen from this level, we could have easily seen the index quickly plummet back to its 200-week moving average.

Now that the market has shown some relative strength, we will likely see smaller, more predictable moves, as it enters chart levels riddled with resistance. These levels of resistance between 2,680 and 2,800 (dotted lines) will likely hinder large moves to the upside, but now that the S&P has gained some support levels with strength, it has a very good chance to continue higher after gaining a decent foothold.

Returning to our standard one-year chart with daily candles, it is very encouraging to see the S&P gain the stronger levels of support between 2,580 and 2,650 (dotted lines). 2,650 was a very key level for the S&P to overcome. If it can hold this level, it will be a great platform for the index to continue higher. With smaller moves expected, and a pullback overdue, 2,650 can give traders the optimism needed to help return the S&P to its former glory. While resistance (solid lines) can be found just about everywhere, the next big hurdle for the S&P will be 2,700. It is highly likely that the index will begin to bounce between support and resistance, but now that the S&P has a few solid levels of support, panic is on the decline and optimism on the rise.

Bobby Raines

Bobby Raines

Bobby Raines is the Managing Editor of the Market Intelligence Center. He has degrees in Mass Communications and History from Emory & Henry College. Bobby worked at a mid-sized daily newspaper before making a switch to covering the financial industry full time in the years leading up to the financial crisis. He has been a member of the Fresh Brewed Media team since 2011 and has served as a writer and analyst. You can write to him at braines@marketintelligencecenter.com or follow him on Twitter: @BRatMICenter.

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