Thursday 14 December 2017

There may be trouble ahead as 'fear gauge' up again

Angela Moon and Caroline Valetkevitch

Bargain-hunters beware. Wall Street's 2pc weekly fall may not be the buying chance for stocks that it might seem.

The stock market begins the last week of June still rattled by the US Federal Reserve's plans for reducing its stimulus efforts, called quantitative easing, or QE.

This week could bring more big intraday swings and volatility as asset managers re-evaluate their portfolios to adjust to the new regime of diminishing support from the Fed.

The CBOE Volatility Index, Wall Street's "fear gauge", rose 10.2pc last week, ending Friday at 19. The index has risen in four of the past five weeks since Fed chairman Ben Bernanke first broached the phasing out of stimulus.

"The angst over the Fed is going to cause people to re-price. Hedge funds are part of that group, but I don't believe they are the only ones selling," said Ken Polcari, director of the NYSE floor division at O'Neil Securities in New York.

"Hedge funds are nimble, so they are the ones that can move the money around. With the VIX at 20, people get fearful – they want their cash."

Mr Polcari said large asset managers were also likely to be moving around money.

With the Fed putting the market on notice that it will be weaned from easy money, possibly beginning before long, investors are going to look at the broad picture, which has plenty of warning signs. Economic growth remains spotty, Chinese credit markets are showing stress and interest rates are on the rise.

One reason for equity investors to worry is the second-quarter earnings outlook. Earnings warnings from companies for the second quarter outnumber positive outlooks by 6.5 to one, the most negative ratio since the first quarter of 2001.

Investors say the impact of Washington's automatic federal spending cuts, known as sequester, is part of the cause.

The sequester has already had an impact on technology companies, and higher tax rates that took effect earlier this year have hurt consumer businesses.

Among the sectors with the worst outlooks for the second quarter, consumer discretionaries top the list with 21 warnings and only two positive outlooks. Technology was another, with 27 warnings and six positive outlooks, Thomson Reuters data showed.

"This quarter will have the most negative impact from the sequester," said Natalie Trunow, chief investment officer of equities at Calvert Investment Management, which has about $13bn in assets.

"Combined with the tapering of QE, it could further dampen market sentiment, so we could be in for a little further softness in the equity market for a couple of months."

Among the 10 companies that have already reported for the quarter, a few have been cause for concern. Oracle posted disappointing software sales and blamed weaker-than-expected sales in Asia and Latin America. Its shares were down 8.8pc at $30.30 on Friday.

Federal Express, while it posted a stronger-than-expected quarterly profit, cut jobs and said it was retiring some older aircraft.

Forecasts for S&P 500 earnings in the second quarter have declined sharply from an April 1 forecast of 6.1pc growth to last week's forecast of 3.2pc growth.

If second-quarter earnings come in as forecast, they would mark a drop from the first quarter's 5.4pc increase in earnings.

However, estimates tend to start out high then get cut as the earnings period nears. Then, typically, companies surpass the lowered forecasts.

"We've had that for several quarters and we could be looking at some of that again," Ms Trunow said.

Banks, which are sensitive to interest rate changes, will be among the earliest companies to report.

US Treasury yields rose to their highest in 22 months as a result of worries about the Fed cutting back its monthly purchases of bonds.

While the reduced stimulus could help if it boosts net interest margins, there are concerns that trading losses could hit some of the biggest banks.

Earnings projections for the rest of the year are better, with third-quarter growth forecast to rise 8.7pc and fourth-quarter 13.1pc, according to Thomson Reuters.

If the Fed's expectations prove correct and the economic data show strength, they will serve as a tailwind for stocks.

"Remember that (Fed) tapering would be a vote of confidence in the market, which would be good news," said David Joy, who helps oversee $708bn in assets as chief market strategist at Ameriprise Financial in Boston.

Despite the week's 2.1pc loss, the S&P 500 has risen 11.7pc for the year without a major correction.

Irish Independent

Promoted Links

Business Newsletter

Read the leading stories from the world of Business.

Promoted Links

Also in Business