Earning season gets the bulls excited

Equity markets enjoyed strong gains last week. Earnings season has just begun in the US, and it did so on a very positive note.

The season began in earnest when Alcoa, the US's biggest aluminium producer, released its quarterly earnings figures. From a trading perspective, it is important to know first what the market expectation was before the results were announced, and to compare the expectation with the actual figure. The market will already have priced in its own expectations, so it is vital to get a gauge of what these are.

In the case of Alcoa, the firm made a profit of four cents a share, a poor result from a historical perspective. However the expectation provided by Bloomberg was for a quarterly loss of nine cents per share, so the result was received far more positively than perhaps was warranted by the headline number.

In July this year, equity markets were beginning to look a little weak before second-quarter earnings were announced. However, 72.3% of S&P 500 companies beat expectations and an enormous rally ensued, with the S&P 500 gaining over 12% in just three weeks.

Bulls will be hoping that the same stellar performance can be achieved again this time. Bears will be looking for weakness, and will pounce if the figures disappoint. But given the conviction with which the bulls are trading, the bears may have to stand frustrated on the sidelines and wait until 2010 to really hit the market. We believe the recovery will not be as strong or as timely as the market is pricing in, but this does not mean we are going to run the wrong way on the streets of Pamplona.

Currency markets, like the equity markets, have extended their moves from mid-March, with the dollar continuing to weaken as equities strengthen. Eurozone countries are particularly worried at the continuing strength of the euro. As a net exporter, the eurozone is becoming less competitive abroad, a very worrying trend for its constituent economies.

There has been a lot of posturing in the US about its commitment to a strong dollar, but so far there is no evidence of any impeding strategy to achieve this. For the time being the trend looks stable and it will take more than posturing to break it.

EUR/USD is trading above $1.47, up roughly 5% on the year, but it is not in completely uncharted territory at these levels. Only 15 months ago it was trading close to $1.60.

The ECB is mandated to keep inflation below 2%, and it follows this mandate religiously. We saw this in the extreme in October of 2008 when it was still concerned with inflation fears even after Lehman Brothers had collapsed, Freddie Mac and Fannie Mae were under state control, equity markets were down more than 25%, and oil was down 30% from its highs.

Policy-makers on both sides of the Atlantic have their thumbs firmly on hold. With eurozone inflation at –0.2%, the ECB should not have to worry about inflation for quite a while, and should not have to raise rates any time soon. The US Federal Reserve, which monitors economic growth and price stability, is less predictable, but all indications are that it is also unlikely to change rates any time soon. So for the time being we will have to keep watching what the markets are doing, not the central bankers.

Commodities continue to surge

With most major markets showing a lot of volatility with little directional bias, the technical picture is a bit unclear, to say the least. As such we expanded the number of markets we look at to investigate if there were any compelling trades out there.

One of the best we found was Antofagasta, the Chilean-based copper mining company traded on the LSE. It has risen an incredible 96% from the start of the year, but has stalled since July and has been trading in a range from 700p to 800p. On Thursday it broke out of this range and we could therefore see the share price testing all-time highs around 880.

A rule of thumb applied by technical analysts is that a break out of a range is constituted as two continuous closes out of the range or a 2% move above it. A close above 800 on Friday would confirm this, but given the volatility of mining stocks at the minute the breakout move could be over by then.

It's also essential when trading a breakout of a range that your risk reward ratio is proportional. For example, if you're trying to make a quick 60 points on a move up then you shouldn't place your stop loss more than 60 points below. That way you are not risking more than you could gain. This is often overlooked but is crucial to a profitable long-term strategy.

Finally, we can't leave without mentioning the incredible rise in gold prices which were continuously making new all time highs last week. Our bullish view, published at the start of the September has worked very well, and it may be time to lock in some profits or trail your stop loss if you did get into a long position.

There is a cautionary note for those gold investors who like to buy the physical metal in dollars, as the dollar has declined the price of gold advances. Therefore, for a euro-based gold investor, any gains in gold prices are largely offset by dollar declines. This is one of the major advantages of spread betting as there is no FX risk.