Long weekends are always nice, but they are always better if one can actually lounge around, not lounge around, or do both. My weekend felt as if the former was out of reach and the latter was dominant. We are going on vacation tomorrow and I had to install an automatic watering system for the gardens we just built. Mind, you, we live in drought country, so the system had to be finely tuned to avoid wasting water. The time it took to adjust every head …
Okay, so now the Dow has busted through the 17,000 ceiling and the S&P is working on new highs, what comes next? Well, the market cannot float on air, or at least it cannot do that for very long. It needs support and, ultimately, the support it needs comes from earnings.
- Aluminum producer Alcoa will get the earnings season started on Tuesday with second-quarter results after the closing bell.
Personally, my expectations about Q2 earnings are modest, given the economic numbers from Q1. Then again, that debacle was an outlier, so maybe I will be wrong. Earnings have continually surprised for some five years now.
- Of 133 pre-announcements from S&P 500 components so far, 97 have been negative, 24 positive and 12 in line with existing forecasts
Now, the above seems less than hopeful, right? Well it is not, at least according to the article I read over the weekend (okay, so I didn’t work every minute).
- That puts the negative-to-positive ratio at 4-to-1 for the second quarter, the lowest since the fourth quarter of 2012. Moreover, that compares with 5.9-to-1 in the first quarter and 5.5-to-1 a year earlier in the second quarter of 2013.
Counterintuitive, right? Well, that may be, but, in fact, a higher negative than a positive is normal for earnings projections.
- Actual earnings growth tends to exceed forecast growth by a sizable margin, because companies and the analysts who track them tend to underestimate profits.
Now, why in earth would companies and analysts underestimate earnings growth? Analysts, at least real ones, try to be accurate, which should leave them on the conservative side, meaning they don’t want to overshoot or undershoot, but under is better than over, credibility wise.
Companies on the other hand are highly motivated to keep estimates low – they want to beat estimates. It makes them look good in the eyes of the shareholders; it helps support the stock price.
- Since the fourth quarter of 2009 when profits returned to growth after the recession, actual S&P 500 earnings growth at the end of each quarterly cycle exceeded the growth forecast at the start of each reporting period by an average of 5.7 percentage points.
That is quite a number in a world that reacts to fractional differentials as small as a tenth of a percent.
- With the Dow and the S&P 500 in record territory and an S&P 500 price-to-earnings ratio of 15.6, the highest in nine years, a substantial break to the upside on earnings would be a welcome development for investors.
Welcome indeed, as earnings are the only underpinning for stocks that have any solidity. They are the foundation of the market, no matter what the breathless media wants to believe, and if they come out higher than expected on average, buckle up. The market will take us all for a ride.
Trade in the day; invest in your life …
