Time for a Rebound?
New York: October 10, 2011
By John Stephenson

Once again all eyes are on Europe as the region's leaders meet to discuss ways to staunch the debt crisis that threatens to engulf Europe 's banks. European leaders have been unable to forge a consensus on how to grapple with the crisis, sending the euro spiralling down to its lowest level against the U.S. dollar since January. All bets remain off for Europe as the proposed enhancements to the European Financial Stability Facility (EFSF) could be scuttled by a disgruntled Slovakia . A deeply divided Slovak parliament could sink the European Union plan, which needs the unanimous consent of all 17 euro members to come into force.

While Europe's problems aren't about to fade from view, another key question hangs over markets—whether the U.S. will avoid slipping into another recession. So far, the data is mixed. American job growth of 103,000 last month was a positive data point but persistently high unemployment and a stock market that is flirting with bear market territory are worrisome signs. Early last week, the S&P 500 was submerged below 1,000, off more than 20 percent from its April high and closing in on official bear market territory.

With concern mounting that a European sovereign debt crisis could morph into a European bank collapse, U.S. financials have been hardest hit of any S&P sector. But with global demand weakening, the materials and industrials sectors have also tumbled making them attractive shopping possibilities for investors should the world economic growth turn positive.

And while the machinations in Europe are likely to be the focus going forward, the start of third quarter earnings reports on Tuesday will give investors something else to focus on. In spite of the doom and gloom that hangs over the market, S&P 500 earnings per share are expected to hit a record $99.19, according to S&P Capital IQ. Thomson Reuters also expects S&P earnings to soar more than 13 percent this year with consumer discretionary companies such as Target, Amazon and Bed, Bath and Beyond, continuing to post stellar results.

But the recent ratio of 2.6 to 1 negative pre-announcements from companies is well above the long term average—a worrisome sign for third quarter earnings. Kicking off the earnings parade is industrial stalwart Alcoa Inc. which has a consensus earnings estimate of $0.23 for the third quarter. Unfortunately, I think that Alcoa's earnings will disappoint as global leading indicators decline and the price of aluminium slumps.

f earnings disappoint across the board, analysts will start downgrading stocks—a move that would send markets even lower. But while the markets may yet plunge, the average market downswing over the last six decades has lasted for only a year, compared with an average 4 ½ year surge during bull markets. If history is a guide, then the current sell off is at the midpoint of its life expectancy, suggesting that the time for investors to sit on the sidelines may be drawing to a close. And with price/earnings multiples in Japan , Europe and America trading towards the low end of their historic ranges, the worst may be in the rear view mirror.

Investors have been yanking money out of the market with mutual fund outflows totalling $10.4 billion in September. Since May, investors have stockpiled nearly $100 billion when fears over the economy's performance and the euro zone first began to intensify. This massive pool of cash on the sidelines could help give stocks a lift when investors decide its time to move back into equities.

American consumers have been paying down debt and are better positioned than they've been for quite some time to go out and spend. Providing a crucial tailwind for consumers has been falling oil prices, which are down more than $20 per barrel from their April peak. American consumers may be battered and bruised, but they aren't done yet.

Stock market sentiment is almost as bad as it was in early 2009. And while Europe remains a worrisome overhang on markets, a deceleration in bad news from the region could signal the bottom for equity investors. Once markets begin to turn, the battered banking, materials and industrials sectors will be the places for savvy investors to head.