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Will stocks spring a surprise?

Earnings season hits higher level of anticipation as bigwigs report this week

Earnings season shifts into high gear this week, and with nearly one-third of S&P 500 names set to post results, investors hope the news provides a catalyst to buy stocks and leave the market’s recent weakness in the dust.

Several behemoths, including Apple, the largest US company by market value, as well as Microsoft, McDonald’s and AT&T, are due to report earnings.

They’ll be accompanied by highfliers like Netflix and Facebook, giving the first real cross-section of the state of corporate America as temperatures rise across the country and investors hope to put the cold weather behind them.

Strategists will also be looking for clues on how badly China’s slowdown hits US corporate results.

The first batch of earnings came out as equities were working their way through a selloff led by trading-crowd favourites like Netflix and the biotech stocks. With the late-week recovery last week, the hope is that the recent volatility has ebbed. If poor results dominate this week’s action, that could reignite the selling.

“We are still off our highs, but we still remain in an uptrend so it would not surprise me to see sideways action,” said Andre Bakhos, managing director at Janlyn Capital in Bernardsville, New Jersey.

“If we were to have a set of earnings releases that were well off expectations to the downside, that could create hesitation in the market.”

A few themes will dominate this week: The outlook for China, the rotation to slower-growing stocks, and results from high-flying trading favourites.

S&P 500 companies’ first-quarter earnings are projected to have increased 1.7 per cent from a year ago, Thomson Reuters data showed. The forecast is down sharply from the start of the year, when profit growth was estimated at 6.5 per cent, but has climbed from a low of 0.6 per cent reached last Wednesday.

That jump occurred despite notable disappointments from IBM and Google. Even with those two lackluster reports, equities still mostly rallied last Thursday.

The benchmark S&P index rose 2.7 per cent for the holiday-shortened week, helping the index recapture nearly all of the declines suffered in the week earlier. The US stock market was closed for Good Friday.

The China challenge

Investors eyeing the impact of China’s troubles on corporate America’s bottom line will have a few spots to pick from, including Apple, Qualcomm and Yum Brands.

There have been warning signs, with IBM saying last week that its disappointing quarterly revenue was due to worsening sales in the world’s second-largest economy and other emerging markets. Earlier in the week, China reported growth came in at its slowest pace in 18 months.

Qualcomm’s revenue for its fiscal year ended September 29, 2013, showed China accounted for nearly half of the company’s revenue. Options activity in Qualcomm has been defensive in nature, with investors paying more money to hedge against a fall than a rise in the stock’s price.

But strategists at Goldman Sachs see this as a buying opportunity, believing the options data shows investors are overly concerned about the quarter.

Apple also derives 13 per cent of its sales from China, according to Thomson Reuters data. The company was once a favourite among momentum investors looking to capitalise on swift price gains, but the stock dropped sharply from all-time highs reached in late 2012. It has been mostly stuck in a range for the last year.

StarMine expects Apple to exceed earnings estimates by one per cent. Notably, Apple has not benefited from a rotation into older tech stocks like Microsoft has. Its shares are down 6.1 per cent on the year.

Big Mo? Uh, no

Along with Facebook and Netflix, momentum names such as Gilead Sciences, Biogen Idec and Illumina are set to post results.

Investors are gearing up for wild swings in those names this week. Trading in Facebook options expiring on Friday suggest investors expect about a 12 per cent move in the stock’s price by the end of this week. Weekly options are often used in advance of a major event like earnings. Similarly, Netflix options also suggest a 12 per cent move.

After a spectacular performance in 2013, the selloff in many of these stocks over the past few weeks has contributed to the market’s volatility. Whether they affect the broader market may determine how well stocks trade this week.

The Nasdaq biotech index is down nearly 19 per cent from its closing high on February 25 while the Global X Social Media Index ETF is down 18 per cent from its March 6 high. However, both have bounced off drops of more than 20 per cent that had sent each into bear market territory.

With the nervousness created by the declines in the momentum names, investors have rotated into more defensive names.

“What happens at some point is [momentum names] become disassociated from the market at large. People see this happening, they become scared, and they start selling other companies as well,” said Stephen Massocca, managing director at Wedbush Equity Management in San Francisco.

“It gets to a point where that stops happening and the rest of the market — outside of these crazy names — is not that overvalued,” he added.

Some of those names, including Dow components Microsoft, DuPont and Travelers, are among those identified by Credit Suisse quantitative analysts as potential “contrarian” picks as they’re among the least loved by Wall Street analysts.

All three are also considered undervalued by StarMine’s measure of intrinsic value that looks at the long-term growth expectations for these names.

Microsoft, for example, is the third-best performer in the Dow this year, having gained seven per cent for the year. Reuters