The Day Ahead: Chants From an Unhinged Market

 | Nov 01, 2012 | 8:00 AM EDT  | Comments
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"Did you know that I'm utterly insane?" --Patrick Bateman, American Psycho

What we call the "stock market" is a downright impressive organism. Every second that ticks by, the market is acting kind of insane at a Patrick Bateman level, whether it's via a hotshot human or a buzzing machine. "Buy or sell?" "Good news or bad?" "Who wins and who loses?" These are a few of the issues that the market weighs daily. To that end, the market returned from a rare, non-self-induced slumber with vigor -- and absent the Friday the 13th disaster scenarios. But, deep in my very soul, I truly feel that investors ignored many important insane, silent chants from the market regarding its next move. Amid the window-dressing nonsense and the like, the market was crying, for it has been unable to shake the nasty fever it has carried around for weeks.

I began the session with an open mind, thanks to four full days of analyzing everything and anything (as evidenced on Twitter). However, when all was said and done, there was a simple "Pour one out for my fallen homie" moment -- that homie, Mr. Market.

Broad Observation: Sandy on the Brain

It was a continued dreary earnings season. Downside fundamental risk from China and Europe – which constituted a greater deciding factor -- served as wet rags to any companies that were perceived as Sandy beneficences. Of note is that Home Depot (HD) and Lowe's (LOW) finished well off their session highs. At the same time, we saw retreats in Wal-Mart (WMT) and PetSmart (PETM) -- pets needed pre-storm food, too. Also receding was RadioShack (RSH), which doesn't sell much normally, but did score traffic for phone chargers. Interpretation of all this: The market is looking at the bigger picture.

New Observations

On Wednesday, there were three focus stocks for me -- Eaton (ETN), BorgWarner (BWA), and U.S. Steel (X). The plan had been to use the market's reaction to each earnings report in order to gauge whether the market was, in fact, oversold. I would have been able to make that determination had these stocks rallied convincingly, if at all, in the face of soft third quarters and fourth-quarter commentary.

Unfortunately, only Eaton managed encouraging action -- and due to company-specific factors, in my humble view. These included such metrics as new orders booked in October (watch for this from other heavy industrials). As a result, I assigned greater weight to the market's muted response to a potential trough earnings scenario from BorgWarner, which proffered an eek-type guidance revision. With U.S. Steel, as well, the market ignored favorable comments on the fact that trough spot pricing had been reached and that prices on new orders late in the quarter.

The read: Valuations are still in adjustment mode to as-yet-unforeseen risk factors in the remaining third-quarter earnings releases and in the fourth quarter. In total, the market continues to be short-term-minded.

Executives continue to highlight "absolute" operating profit margins, not "absolute" operating profit margins plus their direction -- which, we would hope, is higher. This is a small trick that I utilize to gauge confidence in forward outlooks, when I want to feel that sense of "selling the story." I remain disappointed in the stories being told. If CEOs, CFOs or division presidents aren't playing convincing cheerleaders, why should the market throw a bit of enthusiasm in the way of the underlying stock as the company deals with horrid financials?

The market is not enamored with product price increases from companies, hypothesizing that these are unsustainable in the front half of 2013 if volume continues to be suppressed. We have to keep inventory turning in order to drive operating cash flow, so revenue shortfalls could force the hands of management in the form of price discounts.

Where I Stand

It's hard to get long into the jobs report, as there is a ridiculous set of what-ifs. For instance, I fancy the October job headline could print below 100,000, thus theoretically giving a boost to the chances of Republican presidential nominee Mitt Romney. However, this would also point to an economy in increasingly dire straits, and would support the negative tone of earnings season.

The market may also determine that the impending "fiscal cliff" is a major threat to growth that is already surprising negatively, and that it would take considerable time for a Romney administration to chart a path to reversing those fortunes. The best course of action is to be reactionary -- and, overall, I reiterate my bearish stance. We should be prepared to enact long and short positions based on the final jobs report prior to the election. It stinks that the analysis has gotten to such a granular level, but it has, and we have to adapt in order to overcome.

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