Rally runs out of steam

By David Morrison  |  26/10/2018 14:24

Disappointing revenues from two of the world’s biggest tech companies leads to sharp reversal after Thursday’s bounce

Thursday saw US stock indices soar with the Dow closing 400 points (1.6%) higher while the NASDAQ tacked on around 3% and the S&P 500 ended up 1.8%. The moves undid a substantial amount of the damage done in the previous day’s session. However, the US majors once again plummeted overnight following earnings releases from Alphabet (Google) and Amazon after the close. The two tech giants both easily beat the consensus earnings-per-share (EPS) estimates. However, sales (revenues) were a big disappointment in both cases. This is a major concern. It’s very easy to manipulate EPS to portray a rosy picture, but far more difficult to massage revenues. On top of this, Amazon put out some negative forward guidance for the fourth quarter (Q4). The stock was down over 8% ahead of the open while Alphabet lost 5%.

The fear now is that we’re now approaching the peak in the business cycle and that corporate earnings will suffer as a result. This is especially the case as from here on in the year-on-year comparisons get tougher to beat thanks to some astounding sales and earnings numbers from Q4 2017 onwards.

Friday also saw the first look at US third quarter GDP. This rose 3.5% annualised which was better than the +3.3% expected, while the second quarter was revised up to +4.2% from +4.1%.

Next week

Monday sees the release of US Core PCE (Personal Consumption and Expenditure) which is the Federal Reserve’s preferred inflation measure. Last month it came in at +2.0% annualised, which means it’s smack-bang on the Fed’s target. Anything above this will only add ammunition to the view that the Fed is preparing to hike fed funds by an additional 100 basis points between now and the end of next year. Conversely, equities could get a lift, and the dollar weaken, if it comes in below target. We also have the UK Budget where anything could be announced, although the subsequent market reaction is likely to be overshadowed by Brexit news.

On Tuesday we have third quarter GDP updates from France, Germany and Italy. These will be important, particularly if they indicate continued slowing growth across the Euro zone. Italy’s growth prospects are also important given its budget proposals which have already been knocked back by the European Commission. We have earnings updates from Coca-Cola, eBay, Facebook and General Electric.

Wednesday brings a Bank of Japan monetary policy meeting. Watch out for any indication of additional flexibility over targets for the 10-year Japanese Government Bond. We also have ADP Payroll numbers and the Chicago PMI from the States.

On Thursday the Bank of England releases its Quarterly Inflation Report while the Monetary Policy Committee is expected to keep the Official Bank Rate unchanged at +0.75%. From the US we have the ISM Manufacturing PMI and earnings reports from Apple and Starbucks.

Rounding off the week we have US Non-Farm Payrolls on Friday afternoon. These are expected to rise by 190,000 following last month’s disappointing increase of just 134,000. Perhaps of more importance though, Average Hourly Earnings are expected to rise 3.1% from the same time last year. If so, this will be significantly above last month’s reading of +2.8% and would suggest that wage growth could soon be showing up in key inflation data. Earnings from Duke Energy and Exxon Mobil.
 
Technical picture

Thursday’s session saw the S&P 500 inch back above support around 2,700. This gave traders hope that the rally could have legs. A consolidation above this level would mean that the next upside target was the 200-day moving average which comes in around 2,760/70, depending on which moving average you use. However, Friday’s pre-market sell-off saw the S&P trade down to a low of 2,645 before bouncing on short-covering and the better-than-expected GDP release. The next downside target is 2,600 which was a rough-and-ready support area earlier this year, and resistance back in December 2017. Both the MACD and RSI suggest that the index is currently oversold, so bulls will be hoping they can push the S&P back above 2,700 going into tonight’s close. But a failure here would suggest that there’s more pain to come, and it’s worth noting that although volatility (as measured by the VIX) has spiked higher, it is, at 26.8, nowhere near the 38.8 it hit during the Jan-Feb correction. On top of this, although typical safe-havens such as US Treasury bonds and gold have also pushed higher, their moves have been relatively modest. This has led some analysts to speculate that, despite the sharpness of the equity market decline, there’s no obvious panic. This could mean that we are about to see a rally. However, it also suggests that any more disappointing corporate, economic or geopolitical news could spark a fresh wave of selling and the danger of an all-out rout.

 
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