There has been talk of European quantitative easing for years, so one would think its arrival would be priced in. But given the European love of talk over action, it is almost a surprise that they finally pulled the trigger.
The US earnings outlook has already been hit by the strong dollar over the last six months or so.
The strong dollar means overseas earnings are translated back into fewer, more expensive dollars for big US multinationals like JNJ and GE.
And weak oil prices have already tanked earnings projections for the energy sector.
Central Bank Divergence Means Dollar Rally Likely Has Legs
The onset of European QE means that the dollar rally likely has legs, given that the main transmission mechanism for QE is by weakening the easer’s currency. While a lot of this has been anticipated by the market, the fundamentals are lined up for a continuation of the rally.
Reinforcing this trend is the fact that the Fed is approaching the onset of a tightening cycle, however tentatively. The current consensus seems to see liftoff for the Fed Funds rate in June.
How far does the dollar rally have to go? I have no idea, but at 1.07 parity is almost here.
Does Earnings Weakness Portend Market Weakness?
The key thing for US earnings is that the headwind from the strong dollar is likely to continue for at least the next couple of quarters.
And with the likelihood that the oil supply glut will not be resolved for at least a similar time frame, earnings for the energy sector also look to continue their recent weakness.
Given that US stocks are already expensive, it is no wonder that stock prices are feeling some weakness from the onset of Euro QE. Rising forward P/E ratios from falling earnings projections is not exactly a firm foundation for a rally. Forward guidance will be key as we enter earnings season next month.
Time to Digest Our Gains
Then again, GDP looks decent and strong recent payroll growth (and the Wal-mart wage hike) indicates that the benefits of the expansion may finally begin to be felt by the folks left behind so far in the recovery. Good for the little guy, but it may be time for a bit of payback in the stock market. At the least, we look set for a pause to digest our recent gains.