The Fed, the ECB, Brexit and even the U.S. election finally took a back seat to driving stock market results in October as third quarter corporate earnings reports dominated the headlines.  While they got off to a shaky start, with industrial companies such as Honeywell, Alcoa and PPG Industries all missing expectations or pre-announcing, the numbers started to get better once the major U.S. banks took the stage.  To be fair, the bar had been set pretty low for the banks given that their earnings were expected to be down year-over-year as low interest rates, slower economic growth and problem loans were all expected to impact results.   But JP Morgan, Citi, Bank of America and even beleaguered Wells Fargo all beat expectations on strong trading and investment banking results.

Following some strength in the consumer and technology sector results, it’s looking more and more like Q3 will see the first positive year-over-year print for S&P500 earnings growth in two years, albeit in the very low single digits.  With about 60% of the stocks now having reported, about 78% have topped expectations, while 58% have beaten their revenue marks, both slightly better than normal levels. Financials continue to have a great quarter relative to expectations, with 83% of the sector topping their earnings estimate, while a whopping 92% in the technology sector have cleared the bar.  Not coincidentally, those are the two top performing sectors over the past three months.

But the news was not all good in the industrial and metals sectors as giants such as Honeywell, Dover Corporation, Caterpillar, Whirlpool, PPG, Alcoa and 3M all either missed expectations for the 3rd quarter or lowered estimates for 4th.  In the case of worldwide lightweight metals producer Alcoa, the stock fell nearly 20% after its earnings report not only missed profit expectations but revenue fell by 6% year over year, which indicates the lack of global growth and demand for industrial metals.  Multinational industrial giant Honeywell sited worsening growth in the Middle East, Russia and China.  This also showed up in Caterpillar’s results which brought down expectations for the next quarter and added that it expected sales to be at about the same level in 2017, suggesting there is still a glut of mining equipment in the market and the industry is not that close to a recovery.  In addition, this slowdown in GDP growth worldwide was illustrated in trade data from China, which showed September exports fell 10% in dollar terms from a year earlier.  With CAT stock trading in the mid-80’s, the multiple on earnings is over 26 times, which is okay for Facebook or Alphabet, but seems a stretch for a cyclical stock in an industry that is in the midst of a secular slowdown!

The free pass on overhyped stock valuations may just be in the process of ending in a variety of sectors.  UnderArmour, a favourite in the growth sector over the past few years and sporting a ‘very healthly’ earnings multiple of over 50 times, reported sales growth below expectations and saw its stock drop 16% the next day, which still leaves it trading at over 40 times consensus 2018 earnings!  Visa also gave a ‘less robust’ outlook on earnings but continues to trade at over 23 times the 2018 estimate due to optimistic view of its global growth prospects.  With the S&P500 trading at 22x reported earnings, the market needs a huge revenue and earnings rebound to avoid seeing the ‘gravitational forces’ of rising interest rates send stock prices lower.

All of this may not matter in the short term though as the focus may be shifting away from earnings again.  Stocks were all set to finish a flat and uneventful week when news broke midday Friday that the FBI is reviewing new evidence in connection with its investigation of Hillary Clinton’s email server.  That sent the major indexes down almost 1% in 60 minutes, and stocks ultimately ended the week off 0.7%.  With investors expecting a Clinton victory Nov. 8, the FBI’s October surprise induced a new round of market volatility. It also dampened the improved tone that stemmed from news of a 2.9% rise in third-quarter gross domestic product, released early Friday. That had been the best quarterly growth in two years.  So while the remaining earnings reports will continue to be a part of the stock market picture, political risk and the Nov. 3rd Federal Reserve meeting will once again take centre stage!

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