Earnings Season Is Here, and There's One Way to Play It

It's the start of the earnings season, and we all know how that can go.

Alcoa Corp. (NYSE: AA) kicked off April 18 by crushing expectations, and 80% of the companies in the S&P 500 have topped analysts' estimates - and that's in comparison to the previous historic average of 67% of companies that exceeded conjecture.

But, all beats aside, the S&P 500 has dropped 1.3% since earnings reporting started.

And Alcoa, which popped more than 5% and made a new all-time high at $62.35 after it reported, closed Monday, April 30, at $51.20 - down 17.9% a mere seven days after soaring like Icarus.

Overall, the market's performance has been poor, and with the unusual number of companies that beat earnings big-time and have since traded down, it's giving investors a lot to worry about.

It makes one sick of relying on stocks.

Here's why they should be worried, what to watch for, and what to do if it all goes wrong...

Call It a Failure to Launch

Solid earnings beats, solid revenue gains, better than expected bottom-line profits, and mostly encouraging guidance have done little, if anything, to boost investor sentiment. The proof of that is in the pudding: The market's still struggling from when the February sell-off shook everyone to the core.

Sure, the market rallied off its initial February fall.

In terms of the Dow Jones Industrial Average, after reaching all-time highs of 26,616 in late January, the market collapsed to an intraday low near 23,500 in the first week and a half of February. But the benchmark rallied back to near 26,000 by the end of February.

But couldn't get above that.

The Dow then dropped to just above 24,000. Not to worry, it rallied back to the 25,500 range.

Then again, time to worry came out of nowhere when the Dow dropped again, making new lows below the 23,500 early February lows investors had hoped were an anomaly.

Not to worry again, the Dow rallied. This time, however, only to 25,000. That's 500 points below its last attempt to get up off the slippery floor holding it down.

Now, the venerable index is bobbing and weaving like a fishing line without any bait on it, in the 23,900 to 24,400 range.

How Much Fuel Is Left in the Market's Tank?

Lots of issues seem to be holding the market back.

Perhaps the biggest issue is the former leaderships stocks, the principal sectors that ignited the rally since Donald Trump's election. In spite of excellent earnings, these former darlings have mostly struggled to regain their old high ground.

The lack of leadership stocks, which drag the rest of the market higher and higher (as long as they have momentum), is giving bargain-hunting and so-called value investors serious pause.

There's just no conviction. There's no reason to buy out-of-favor stocks if there aren't bulls pulling everyone's wagon up the hill.

Big institutions, though some may have pared positions, are still holding the previous leadership stocks in the hopes that they'll pick up where they left off - when the wails of other investors turn to blind bliss again, that is.

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The problem with holding onto those stocks, because of the crowded nature of those holdings in the hands of hedge funds and active trading desks, is if there isn't another leg up and those stocks get sold (because they are all still sitting on big run-up profits), the rush for the exits could be ugly.

What's more worrisome to me is "passive" investors haven't been passive at all. Passive funds just saw the biggest outflows over the last three months they've seen since early 2009 - before the market started its long bull run.

Those index-chasing passive investors, who just wanted to own all those darling stocks in "packaged" form, are turning tail.

They were the marginal buyers, plowing money into ETFs and indexed mutual funds. They helped institutions layer on profits as they bought more leadership stocks, which drove the indexes higher and subsequently drove passive investors into indexed products.

But oh no, not anymore. That's the stock-specific picture.

The One Thing to Watch Like a Hawk

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The prospect of rising rates also weighs heavily on stocks. Add that to the massive government financing needs, the prospect of rising oil and gasoline prices, possibly rising inflation expectations, and rising interest rates. Did I say that already?

Yeah, rising interest rates.

And there's the rising dollar. The U.S. dollar's on the move lately, coming off the floor it's been sliding around on. It's headed higher because of a few possibilities: Maybe inflation's coming back, maybe the Treasury will have to keep borrowing record amounts, maybe the Fed will raise rates and make the dollar more desirable... Because, as rates rise here, investors elsewhere sell their currencies to buy dollars to park their money here to get higher rates.

Starting to get it?

Stocks are facing a lot. Maybe that's why better earnings haven't lifted the markets.

And maybe, worst of all, maybe the cycle's peaked. Maybe we've reached a "high water mark."

Maybe there's a recession looming out there.

There's only one thing to watch like a hawk now in the short run. The thing that matters most is the support levels markets are dangerously close to.

If the technical support levels the Dow's dangerously close to, the S&P 500 is close to, and the NASDAQ too are tested and broken, the sound you'll hear will be the sound of panic...

...and ringing cash registers as hedge funds and active trading desks dump stocks to book whatever profits they can... and passive investors banging on their keyboards hitting sell buttons... and risk parity funds twisting in the wind, whistling as they sell cross-correlated assets that are all in danger of weighing each other down.

Not that that's going to happen, but, at least if it looks like it could, you'll know what to look for and what to listen for.

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The post Earnings Season Is Here, and There's One Way to Play It appeared first on Wall Street Insights & Indictments.

About the Author

Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.

The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.

Shah founded a second hedge fund in 1999, which he ran until 2003.

Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.

Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.

Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.

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