As Q2 earnings season begins, the market appears to be at a crossroads. A lot of portfolio managers are humming along to the old Clash refrain "Should I Stay or Should I Go Now?" Interestingly, the song has a different meaning depending on how much cash is in the mix.
Based on a sampling of portfolio managers, it appears as though most funds are still weighted towards cash. Recent declines in the market suggest that many who dipped into the market since March have taken profits from the recent run up, and have shored up cash positions again leading into the 4th quarter.
Since the market bottom in March, and leading into the month of July, the VIX had been on a steadying decline and was flirting with an 8-month low. During the most recent correction, volatility has increased as uncertainty begins to creep back into the market.
Investors appear to be uncertain because there are a lot of offsetting data and opinion in the market as reporting season begins. Here are some examples:
- Good quarters are expected from bellwethers such as Google (GOOG), Nokia (NOK), Goldman Sachs (GS), and JP Morgan (JPM). Offsetting these data points, Q2 performance in many sectors could be weaker than expected as analysts overshoot the "green shoots". This could be especially true in the commodities and materials sectors as hedging in some commodities like oil distorted pricing. In general, investors may see more surprise earnings "misses" than surprise "beats" in many sectors (including technology) for Q2 with greater than anticipated pressure on margins. See Dell (DELL) and Matrikon (MTK) as prime examples. YoY declines in performance in the commodity sector should be significant as Q2 2008 was positively impacted by a commodities bubble.
- Positive analyst statements regarding the financial sector, positive resale housing data in Canada, better than expected job loss performance, and improving CEO sentiment point to positive economic conditions leading into the 4th quarter, and into FY2010. Offsetting this positive sentiment, unemployment is still increasing, and there are whispers that the U.S Administration may need to apply more stimulus to the U.S economy, implying that the "green shoots" are tenuous and in danger of shriveling, and that the positive sentiment may not yet reflect reality.
- The positive impact of government stimulus programs should begin to show up in construction, materials, commodities, and technology sectors during Q4. However, these positive benefits are likely to be offset by the impact of new regulations related to commodity speculation planned by the U.S. Government, and the potential for passive trade protectionism.
These are but a few examples of multiple offsetting data points that investors are mulling over during this reporting season. For every positive data point, there appears to be an offsetting negative data point to consider. Hence, investors are at a crossroad.
In the Tech Sector, there was a pretty strong move from the lows of March. In discussions with my friend Adam Adamou from Caseridge Capital it appears that, exiting June, the market had been priced to imply a 12% to 15% increase in gross margins over the coming year. For the previous year, the actual decline of GM was 15%, and for the March 2009 quarter, GM growth was measured at 0.5%. The market was pricing a snap-back recovery that is a lot to expect from any sector considering the level of economic uncertainty. The recent correction brings more credibility to future expectations.
The uncertainty regarding Q2 earnings appears to be setting up for a volatile few weeks of trading, but not a lot of movement until the end of the summer when nicely tanned portfolio managers begin to redeploy cash.
When they return to the markets, Portfolio Managers are likely to find healthcare, technology, and consumer staples stocks with lots of cash and low debt ratios to be attractive. The long-term prospect of the financial sector is a little more uncertain as new regulations impede future earnings potential. Although Canadian banks may look a lot better than their American counterparts. Commodities are likely to rebound as the market begins to drool again for 2010 BRIC demand. With respect to the US tech sector, AMZN and CSCO still look good.
Disclosure: I own CX, BWC, DSG, CSCO shares.