Expect the rally to continue with more better-than-expected earnings

On the back of better-than-expected earnings from major companies such as Microsoft, Apple and Ford, stock markets have been rallying this week. The S&P 500 closed on Friday at 1,102.66, while the Dow closed at 10,424.62. For the week, the S&P 500 is up 3.55%, while the Dow is 3.24% higher. It is just as what I wrote on July 11, before earnings began, that “I expect markets to continue rallying...on the back of mildly positive earnings.”

From a technical perspective, the S&P 500 closed at 1,102.66 on Friday, which is just above the psychological 1,100 level for the first time in one month. In fact, the index is officially out of correction territory, being only down 9% from April's high. Another piece of good news is that, according to Bloomberg, of the 149 companies that have reported earnings since July 12, 85% have beat analyst expectations. This is significantly higher than the historical average, and much higher than last quarter's beat rate of 63.7%.

The completion of the Euro zone bank stress test on Friday, with its better-than-expected result of only 7 out of 91 banks failing, should remove some uncertainty for investors. In addition, earnings this week from companies such as Chevron (CVX), DuPont (DD) and Boeing (B) should continue to beat expectations. 

Thus, I expect North American markets to continue rallying this week. Of course, the factors that could dampen the rally are bad economic data from the U.S. and the Euro zone. For the Euro zone, Hungary is currently the country where bad news is most likely to emerge, due to its wrangling with the IMF and EU over a bail-out package. For the U.S., consumer confidence and weekly initial jobless gains data being released this week have the potential of weakening the rally.

It's all about earnings this coming week

One week can certainly change a lot of things. Last week, investors were worried about a double-dip recession. This week, on the other hand, has been a great one for stocks, as the Dow has gone up for 4 days in a row to close at 10198.03 on Friday. In fact, major indices have risen about 5% this week. This has been caused by some encouraging economic and consumer data. For example, the IMF raised its world economic growth forecast for this year from 4.2% to 4.6%.

Despite the positive developments this week, fund tracker EPFR Global stated that US$11 billion left equity funds, while US$33.5 billion entered into the safer money market funds. In addition, Bespoke Investment Group noted that sentiment is at its lowest since May 2009. Meanwhile, the American Association of Individual Investors stated that bullish investor sentiment fell to just 21 percent last week, which is the lowest since early March 2009.

The markets are now turning to earnings for direction, as Alcoa Inc kicks off the earnings season after markets close on Monday. Other companies that will report earnings this week include Google Inc, Intel Corp, JPMorgan Chase & Co and Bank of America Corp.

Ever since the end of the recession, US companies have posted great earnings, which has partly driven the spectacular rally from the March 2009 lows. The good earnings have partially been caused by extensive cost-cutting. At this stage in the recovery, investors are increasing not only looking at the bottom-line (profits), but also the top-line (revenues). 

However, with investor sentiment being currently so bearish, earnings that are mildly positive are all that are needed to keep markets rallying. Thus, with bearish sentiment providing the perfect backdrop, I expect markets to continue rallying this week on the back of mildly positive earnings.

Markets continue to fall as U.S., Europe and China fears persist

It has certainly been a very tough week for markets worldwide. As of Friday, the Dow has fallen 7 days in a row, which is the longest negative streak since it fell for 8 days in a row in October 2008, during the depths of the financial crisis. In Canada, the TSX faced a similar fate as it ended the week down 511.79 points, including a 343.17-point drop on Tuesday.

The markets were dogged by 3 concerns this week: economic growth in the U.S., Europe and China. Early this week, there was a concern about the health of European banks as the ECB ended its program to make 1-year loans to banks, forcing banks to repay $442 billion. However, banks' subsequent demand for ECB's 3-month loans only totalled $131.9 billion, which was far lower than market's expectations of $200 to $250 billion. This showed that European banks were more well-capitalized than some had feared.

Tuesday's heavy fall for markets was a good overview for the whole week, as economic fears for the U.S., Europe and China pushed the Dow down 268.22 points and the TSX down 343.17 points.

Of the factors troubling markets this week, I think only the U.S. economic worries are justified, with the worries for Europe and China being overblown. With the U.S. unemployment rate at 9.5% and decreasing extremely slowly, U.S. economic growth in coming years will be slower than in previous cycles. This should be priced into stocks, and it is in fact being done.

However, a lack of bankruptcies in Spanish regional savings banks, and this week's low demand for the ECB's 3-month loans shows that the European situation is better than many are fearing.

As for China, the Conference Board's downward revision for its April leading economic indicator for China was the reason for fears of weak Chinese growth this week. However, the upward revision by the government for last year's GDP growth from 8.7% to 9.1% is a perfect example that the country continues to grow at its usual rapid pace. Similar to the U.S., monthly economic data emerging from China will continue to drive markets up or down on a given day. However, the fact remains that the economy there continues to grow at an 8 to 10% rate, with the government working to cool or stimulate the economy as the need arises.

Thus, while economic fears for the U.S. are seemingly justified, fears for Europe and China are overblown. Therefore, there is upside potential when investors realize this. However, it seems that fears will remain in the coming weeks, and I expect U.S., Europe and China fears to continue to pull markets lower this week.