Big news for earnings, the economy and taxes


Big news for earnings, the economy and taxes

What in the world is happening in corporate America? The past couple of weeks have provided a bevy of embarrassing headlines about some of the country's most prominent companies. Investors last week had to digest a major disappointment from General Electric, while also learning that the problems at Wells Fargo extended beyond the retail banking business and into the investment side, suggesting a companywide culture issue. Yet the market still rambles on, with October shaping up to be one of the best months of the year. The Dow is up about 4 percent for the month, suggesting that stocks could end the year with some serious momentum.

Here's what investors will be munching on this week:

As seems to be the case often these days, we'll have to wait until the end of the week for the biggest economic news. On Friday, the government will release its first reading of third-quarter GDP, an accounting of all the goods and services the economy produces. Current estimates vary widely: FactSet figures the number will be around 2.2 percent, the Atlanta branch of the Federal Reserve pegs it closer to 2.7 percent, but the New York Fed sees growth of only around 1.5 percent. This all matters because stocks have surged this year on two principal beliefs: that the economy is going to start running hotter than the 2.1 percent average growth since the Great Recession ended, and that Congress would pass some sort of tax reduction/reform before the year is out. With Washington legislators on the verge of a budget deal (more on that later), economic growth should be coming along as well. This year's rally could hinge largely on that .

Earnings onslaught

If profits drive stocks, then this week the market will be in the fast lane. Investors will hear third-quarter earnings reports from 189 members of the S&P 500, the biggest week of the season and one sure to move markets. That group includes 12 of the 30 companies that make up the Dow industrials. So far, earnings season has been pretty ho-hum. About 76 percent of companies reporting so far have beaten Wall Street's bottom-line profit estimates, while 72 percent have exceeded sales expectations, according to FactSet. That's out of 17 percent of the index that has reported so far. While that sounds pretty good, actual profit growth has been pretty tame at 1.7 percent. That's not much for a market that continues to power forward. There has been one interesting change in trend: Recent earnings quarters have seen investors not reward companies much for topping estimates. This quarter, companies beating estimates have risen an average 1.6 percent in the two days after reporting, which is considerably above the long-term average of 1.2 percent, according to Fact Set. If you trade the market, that's an important number.

Hopes for tax reform

The Senate's move last week to approve a budget for 2018 was a milestone — partisan though it was. It not only represented the breaking of a political logjam when it comes to passing a full annual spending plan, but it sets the stage for getting tax reform done. Many Wall Street pros had begun to dismiss the possibility that the Trump administration would be able to achieve its hopes to cut corporate and personal taxes and reform the tax code before 2017 runs out. That still seems like a lofty goal. But even if Congress can get something down by early 2018, that would be a major development, opening up the possibility of getting true tax reform through for the first time since 1986. Greg Valliere, the astute observer of how Washington and Wall Street tie together, had this to say about the current state of affairs: "We've been predicting enactment of a bill by spring; now we think late winter is possible. These folks are serious — they want a victory, and they want it fast. Avoiding a House-Senate conference committee is a strong signal that they plan to steamroll a bill through Congress ASAP." A quicker-than-expected move in Washington could have big market ramifications.

The last word

We'll close this week on the earnings theme. Getting tax reform through would be great, but for the bull market to really rock on, we'll need to see that companies can keep profits rolling. Michael Arone, chief investment strategist for U.S. SPDR Business at State Street Global Advisors, sees cracks growing in the earnings foundation that investors need to watch: "Like many investors, I believe that earnings are the most important determinant for the future path of stock prices. Better earnings certainly have been the major driver of the post-election rally. "Now, however, earnings growth is decelerating at a time when valuations are stretched, potentially creating a big risk for the market. If tax reform fails to get off the ground while monetary policy conditions tighten and earnings decelerate, it could finally spell the end for the long bull market. ... Investors must prepare to protect portfolios from unexpected and unwelcome risks in the market."