Stock market direction over the next few days looks dependant on the answers to a couple of key issues. The first is whether the US reporting season will be good enough to sustain valuations at current high levels. The second is whether recent softness in metals prices is going to develop into a more significant sell-off.
The US S&P 500 index is currently trading at around 17.8 times forward earnings. This is close to last year’s peak of 18.1 and well above the average since the beginning of last year. This makes the market vulnerable to any disappointment in earnings. So far the overall results from the March quarter have been a bit better than expected in terms of both sales and revenue.
However, significant revenue misses by the headline stocks Apple and Twitter may dampen investor confidence this morning given the US market’s leading role. While Twitter’s disappointing revenue growth is a stock specific issue, this is a little less clear with Apple. Although Apple faces increased competitive pressure, investors also have concerns about the declining growth in the overall market for smart phones in the face of consumer caution and a maturing market.
Metal prices have softened in recent days. How far this sell-off continues may provide some clarity on the extent of improvement in China’s demand this year. Steel and iron ore prices have been frothy recently so resource stock investors are likely to be tolerant of some price correction. However, markets are now priced for a more sustainable improvement in Chinese demand based on an increased focus on stimulus. Investors will begin to doubt this outlook if metals prices fall too far.
Markets will have a watching brief on Australia’s inflation data this morning. The RBA has already signalled that inflation is low enough to allow it to cut rates should that be necessary. Given its reluctance to cut rates further unless the economic outlook deteriorates, changes to inflation are unlikely to influence the RBA’s near term thinking at this stage.
Next week’s bank profit reports are now close enough to keep investors cautious. Markets are waiting for clarity on bank bad debt provisions and whether interest margins have been sustained in the face of increased competition.