It’s up to corporate America to keep the rally going – CNBC

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Stocks start the earnings season at record highs, and now it’s up to corporate America to keep the rally going.

About 65 S&P 500 companies release earnings in the first big week of the second-quarter reporting season, with blue chips Johnson & Johnson, American Express, Goldman Sachs, Microsoft and General Electric among them. Profits for the S&P 500 companies are expected to rise more than 8 percent after the first quarter’s 15 percent gain, according to Thomson Reuters.

Earnings are expected to carry the ball for market bulls, but there will also be a strong focus on central banks and Washington after a number of big surprises in the past week. For one, Fed Chair Janet Yellen upended a global move higher in interest rates, as well as a turnaround in the dollar, with surprisingly dovish comments on interest rates and inflation.

CPI inflation data came in soft Friday, and that reinforced her caution. That helped boost stocks, but it broke the uptrend in sovereign yields, and now has traders focused on meetings by the Bank of Japan Tuesday and European Central Bank Thursday. Fed officials meet the following week, and they don’t have speaking engagements in the week ahead of a meeting.

There was also a stunning revelation from Donald Trump Jr. that he agreed to meet last year during the campaign with a Russian lawyer, who was offering him dirt on Hillary Clinton with the blessing of the Russian government.

Stocks shrugged that off, but traders kept their focus on Washington, as the Senate released a new health-care bill due for a vote in the coming week. That vote could either help boost market expectations that some part of the Trump agenda will be completed, or discourage it.

“The market from a sector perspective is focused on Trump, but the market overall is not focused on Trump. But as long as you’re getting good earnings, the market will continue to give Washington time,” said Daniel Clifton, head of policy research at Strategas.

Clifton said the Congressional Budget Office scoring of the bill should show that 22 million people will lose insurance and that costs do not immediately go down. The vote could come Thursday, and it’s not clear how many senators will support it.

“This has been a bad week for the agenda. I can’t stress that enough,” Clifton said. If the health-care bill fails, and negative Russia-related headlines continue to emerge, “That’s not helping you get tax reform done.”

He said in the third quarter, Congress will be focused on budget issues and the debt ceiling, but he and other political strategists expect by the fourth quarter, there will be an active effort to get tax reform underway. “This is a larger story. The market doesn’t expect tax reform. There are investors that tell you they think they’re not going to get tax reform. If you look at a basket of high tax stocks, it’s significantly under-performing the S&P 500,” he said.

What comes after the ‘Trump trade’?

Daniel Suzuki, Bank of America Merrill Lynch equity strategist, said he doesn’t believe the Trump trade has been entirely washed out of the market. That trade, popular right after the election, boosted stocks that would benefit from tax breaks and fiscal stimulus. The trade has mostly been unwound, and if it looks like tax reform will be approved, the market should rally.

On the other hand, Suzuki does not think the market would have a negative reaction if health care fails because it is no longer as closely tied in investors’ minds with tax reform as it once was. “It doesn’t really preclude that the market would rally on the small probability that tax reform gets done,” he said. “The market as a whole doesn’t really care about health-care reform, only in the sense it’s a leading indicator of other stuff getting done like corporate tax reform.”

“There’s some concerns that we’re at an inflection point for growth,” he said. “There’s been some indicators that have been slowing, but the idea that we’re going to get a boost to corporate profits and lower taxes I think would be a boost to confidence and expectations for growth, at a time when people are looking for less growth.”

Suzuki said he is currently cautious on the market and a decent earnings season could help the market but it may also bring some bumps. “I think the problem is expectations are already pretty high,” he said. “I think if the commentary is pretty good that could be supportive of the market. The guidance itself has the potential to disappoint. Our numbers are lower than the consensus for the third and fourth quarter. There’s a potential that offsets some of the positive commentary you’ll see. I think it will be mixed.”

Suzuki said BofA is looking for value stocks to outperform growth, like tech, in the second half. He said the FANG stocks are overvalued, and are a crowded trade. FANG is made up of Facebook, Amazon, Netflix and Google’s parent, Alphabet.

Bank of America’s year-end target remains 2,450 on the S&P 500, below Friday’s close. The S&P 500 finished Friday at 2,459, up 1.4 percent for the week.

“I think there’s a lot of risk to the market, some of the growth indicators have rolled over, and leverage is high at a time when interest rates are rising. Monetary conditions are getting a little tighter. Central banks are moving toward a tightening bias,” Suzuki said.

Economists expect the European Central Bank on Thursday to leave rates unchanged, but ECB President Mario Draghi could talk about the central bank’s quantitative easing program.

Marc Chandler, chief foreign exchange strategist at Brown Brothers, said he is watching the ECB because it is one thing that could turn around the dollar’s losses in the coming week.

“Most of what they’re going to do is change the risk assessment away from increasing their asset purchases. That’s a step toward tapering,” Chandler said. “They don’t want to taper. They’re just removing the downside risk that policy has to be eased further.”

There is no major U.S. data in the coming week that could influence the market’s view of Fed policy. There is however, important retail sales, industrial production and GDP from China, released overnight Sunday.

The S&P 500, the Dow, Dow Transports and Russell 2000 all closed at record highs. The Nasdaq was about a half percent away from its high. The dollar index ended the week nearly 1 percent lower, and the 10-year Treasury yield was well below the week earlier level of 2.39 percent. It touched 2.26 percent Friday, and was at 2.32 percent late in the day.

What to watch

Monday

Earnings: BlackRock, Netflix, Cintas, JB Hunt

8:30 a.m. Empire State survey

Tuesday

Earnings: Bank of America, Goldman Sachs, Johnson & Johnson, Lockheed Martin, Novartis, UnitedHealth, Charles Schwab, Comerica, TD Ameritrade, IBM, CSX, United Continental, Yahoo

8:30 a.m. Import prices

10:00 a.m. National Association of Home Builders’ survey

4:00 p.m. TIC data

Wednesday

Earnings: Alcoa, Morgan Stanley, US Bancorp, American Express, Qualcomm, Northern Trust, Textron, Canadian Pacific Railways, Crown Holdings, Eagle Bancorp, Kinder Morgan

7:00 a.m. Mortgage Applications

8:30 a.m. Housing starts, building permits

Thursday

Earnings: Abbott Labs, Microsoft, Visa, SAP, Travelers, Unilever, Union Pacific, Bank of NY Mellon, Capital One, Danaher, KeyCorp, Blackstone, eBay, Paypal AutoNation, PPG Industries, Genuine Parts, Snap-on, Sonoco Products, ETrade, Ruby Tuesday

7:45 a.m. European Central Bank rate decision

8:30 a.m. ECB President Mario Draghi press briefing

8:30 a.m. Jobless claims

8:30 a.m. Philadelphia Fed

10:00 a.m. Leading index

Friday

Earnings: General Electric, Honeywell, Colgate-Palmolive, Schlumberger, Autoliv, Synchrony Financial

It’s up to corporate America to keep the rally going – CNBC