Over the next four weeks, we’ll learn who will be President for the next four years, how companies performed in the third quarter, and Europe’s plan for further integration of its financial system. That’s a lot of news, and that news is likely to create movements in the market. As we parse through all the information, we’ll be watching for the news that will actually move the market from what we believe is just noise. We consider market-moving news to be: news that gives us clues to companies’ future earnings, and news that gives us clues to the future of interest rates.
The presidential election is important because it may have an impact both on how much companies earn and on interest rates. Up for debate is how to deal with the United States’ growing deficit. As we see it, there are three ways to deal with the deficit: First, raise taxes. Second, raise growth, which increases tax receipts. And third, raise inflation so that the dollars we have to repay are worth less than the dollars we borrowed. Growth is everyone’s first option, but few economies have ever outgrown their debt issue. Tax changes and inflation seem to be more likely occurrences. Higher corporate taxes could weigh on corporate earnings and thereby equity prices. More inflationary policies would signal higher future interest rates and as a result likely lower stock prices. How each candidate would deal with the deficit as President is a major consideration.
Over the next four weeks, companies will report third-quarter earnings. Ever since the depth of the recession, U.S. corporate earnings have continued to surprise Wall Street analysts to the upside. During the last three years, most of the gains have been from greater efficiency (e.g., cost-cutting or increasing worker productivity), as opposed to strong revenue growth. At some point, all the costs will be cut and earnings growth will require some degree of revenue growth. As earnings start to be reported, we’ll be looking to see if earnings are benefiting from the recent quarter’s uptick in spending and employment. We would like to see corporate revenue growth as a sign that future earnings growth rate projections are sustainable.
Finally, there is Europe. Spain may ask for a formal bailout in the next four weeks. That bailout will be the final test of how well Europe has managed to build its backstop to put a halt to its slow-moving debt crisis. Almost more importantly, we expect to see some movement over the next four weeks in Europe’s plan to produce a continent-wide bank regulator. Such a move would do a lot to calm market fears about a eurozone breakup, and thereby reduce interest rates in Europe and aiding stocks overseas.
There is going to be a lot of action to watch over the next four weeks. We will be monitoring the situation closely, and then looking to take advantage of opportunities where applicable and updating you with our thoughts.