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Nine Post-Earnings Season Predictions


US equities, the dollar set to outperform.

Short-Term Prognosis

At the risk of sounding obvious, I'll make 2 observations about the US market in the short term: First, at this moment, the overall psychology has dramatically shifted to one that's placing a premium on bad news and a discount on good news. Second, earnings will be the main fundamental driver for the market in the next 2-3 weeks.

At current levels, the risk/reward ratio seems pretty good on a trading basis. This is particularly true given my positive outlook for earnings. Upside could easily be to S&P 920, while downside beyond 850 seems fairly unlikely in the short term unless there's major unexpected news.

Medium-Term Prognosis

Looking beyond the earnings season to the medium term, things will become complicated for various reasons, which I'll discuss in detail in the coming weeks. For now, I'll mention a few key issues:

1. The focal point of the financial crisis expands beyond the US.

Europe and Asia -- China in particular -- are likely to become the focal points of the second stage of the global financial crisis that was kicked off in mid 2008. Europe's overall economy and financial system are in considerably worse shape than those of the US. And the export dependency of the Asian growth model is going to become painfully evident starting in late 2009. Commodity-based emerging markets such as Russia and Brazil will be hit extremely hard. This is something that I've been talking about on Minyanville since at least mid-March of 2009 (see Will Troubles Abroad Stop a Countertrend Rally).

2. US recovery momentum will slow.

The secret to the countertrend rally was the pent-up demand that juiced economic data from March-June. Now demand will "normalize" at a lower level than the run rate in the second quarter. Economists didn't capture this phenomenon of pent-up demand, and because of the linear way in which they model, they're likely to get surprised again and be forced to tweak their numbers down during the second half of the year. I discussed all of this previously in Surprises Continue to Drive the Rally.

3. Obama's honeymoon is over.

The counter-trend rally was fueled partly by optimism regarding the ability of the US government to engineer an economic recovery. The end of Obama's honeymoon and his sinking popularity will be a proxy for declining public confidence in the ability of the government to manage the economic crisis. This has major implications for consumer and business confidence that drives consumption and investment expenditure.
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No positions in stocks mentioned.
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