Disappointment Setting In?

Daily State of the Markets 
Tuesday Morning – July 20, 2010  

One of the most interesting things about the stock market game is that it is constantly changing. Think you’ve got it figured out? You might want to think again, because oftentimes, the baseline assumption of the game can change overnight.

Take earnings, for example. Normally, understanding a company’s earnings report is pretty straightforward: If the numbers beat the street’s estimates (i.e. the Reuters or First Call consensus) it is rewarded with a higher stock price. Never mind the fact that the analyst estimates are almost never accurate (or even close), the earnings game is usually about expectations versus reality. And for this reason, analysts have been expecting this season’s earnings parade to be strong once again.

However, a funny thing might be happening on the way to the stock market rally that usually presages a strong earnings season. Despite the vast majority of reports coming in above expectations (86% as of Friday), some disappointment may be setting in.

Let’s look at a quick example or two. After the close on Monday, IBM (IBM) beat earnings estimates by $0.03 and increased their guidance for the coming quarter by a nickel. The result? The stock instantly traded lower. Texas Instruments (TXN) met expectations (which had been guided up nicely on June 8th) and boom… the stock goes down 6%. What gives?

The problem is that companies such as IBM aren’t supposed to simply beat expectations; they are supposed to surpass the consensus by a meaningful margin. While the $0.03 “beat” that IBM put up wasn’t half bad, it also didn’t produce much enthusiasm. And then there is the revenue number. Don’t look now fans, but IBM, like a disturbingly large number of companies so far, “missed” on the top line. And in short, if this trend continues much longer, traders might start to expect less going forward.

The key here is that at this stage in the economic cycle, we’d like to see revenue numbers expanding robustly. This would tell us that business is good and it is only a matter of time before companies need to beef up their payrolls to keep up with demand. However, the opposite is also true. If the revenue growth doesn’t materialize, then payrolls aren’t going to expand. And since analysts had been hoping that corporate America would start adding jobs soon, well, disappointing revenue growth is NOT what stock market bulls are looking for at this stage of the game.

Turning to this morning… Stocks futures are moving down as more companies continue to miss revenue targets (this morning BK, JNJ, and GS all reported revenues below consensus). Thus, it appears that the lows of the recent correction will be tested in the early going.

On the economic front… Housing Starts fell 5% in June to an annualized rate of 549K, which was well below the consensus for 576K. Building Permits for May rose 2.1% to 586K. This was above the consensus of 567K and the May total of 574K.

Finally, consider raising your expectations. As Michelangelo said, the danger is not that your hopes are too high, but rather…

Pre-Game Indicators

Here are the important indicators we review each morning before the opening bell…

• Major Foreign Markets:
  • Australia: +1.05%
  • Shanghai: +2.15%
  • Hong Kong: +0.86%
  • Japan: -1.15%
  • France: -1.16%
  • Germany: -1.25%
  • London: -0.71%

   

• Crude Oil Futures: – $0.63 to $75.91
• Gold: – $1.50 to $1180.40
• Dollar: lower against Yen, higher vs Euro and Pound
• 10-Year Bond Yield: Currently trading lower at 2.93%

   

• Stocks Futures Ahead of Open in U.S. (relative to fair value): 
  • S&P 500: -12.75
  • Dow Jones Industrial Average: -122
  • NASDAQ Composite: -28.78  

Wall Street Research Summary

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