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As tends to be the case during corporate earnings season, the stock market has been volatile over the last week. While corporate earnings have been as strong as I suspected, I have to admit that I am more than a tad surprised by the market strength given Standard & Poor's revised long-term credit rating outlook for the U.S. from "stable" to "negative," rising concern over the looming domestic debt crisis and the tepid outlook on the part of the consumer.

Of course, that is the nature of earnings season as the market tends to be swept up by the latest news and earnings beats or short falls. In this case, it's the number of companies reporting either better than expected quarterly results or increasing respective near term forecasts that has fueled the market move on Wednesday and Thursday.

Or has it?

Watching Earnings Beats and Outlooks

According to data compiled by BeSpoke Investment Group (BIG), the earnings "beat rate" -- the percentage of companies beating earnings estimates -- this earnings season is not looking so great. BIG estimates 64 percent of U.S. companies have beaten earnings estimates so far this earnings season. On its face, that sounds like a pretty good number and a quick scan of the headlines confirms this ratio – for every Apple (NASDAQ:AAPL), Qualcomm (NASDAQ:QCOM), W.W. Grainger (NYSE:GWW), United Technologies (NYSE:UTX) and Eaton Corp. (NYSE:ETN) that shattered Street expectations, there are those, such as Badger Meter (NYSE:BMI), Marriot International (NASDAQ:MAR), Harley Davidson (NYSE:HOG), Kimberly-Clark (NYSE:KMB) and others that missed expectations. To put BIG's 64 percent calculation in context, it would be the weakest earnings beat rate since April 2009, but still ahead of the 62.5 percent level the beat rate has averaged since 1998. To be fair, it is still early in the cycle for March 2011 earnings, but BIG's work has revealed that the beat rate tends to drift lower from the beginning of earnings season to the end.

BIG goes on to point out that while an earnings beat is generally a good thing, the "price reaction to the report is the ultimate arbiter of whether the report was good or bad." In other words, was the earnings beat already expected or not? Did a company's earnings beat fall below what those around the Street thought the company was capable of delivering, or as it is better know "the whisper number"?

Outlooks and Input Costs

In recent weeks, we have seen a number of negative revisions to 1Q 2011 GDP forecasts, the consensus of which now stands at 1.7 percent per Briefing.com. Those revisions reflect spotty economic data as well as the impact of higher gas and food prices. Other than corporate earnings, we've received a number of data points in recent days that continue to suggest a mixed economic recovery. While there are bright spots such as industrial production, the Empire State Manufacturing Index and others, we continue to see oil and gas price tick higher, the Philly Fed Index for April significantly miss expectations, companies such as McDonald's warn on food inflation and weekly jobless claims back over 400,000 for the second week in a row.

To me those GDP revisions and the reasons behind them place even more importance on corporate outlooks this earnings season, in part to see how companies are managing their cost structure as well as the ability to pass-on price increases. With regard to inflation, anecdotal signs continue to emerge as companies begin to deal with sustained increases in key input costs:

  • McDonald's (NYSE:MCD) now expects food costs to rise between 4 percent and 4.5 percent in the United States and Europe in 2011, up from 2 percent to 2.5 percent higher in the United States and up between 3.5 percent and 4.5 percent in Europe as it previously forecasted in January.
  • J.C. Penney (NYSE:JCP) CEO Myron "Mike" Ullman shared this week that higher cotton prices are a major concern for apparel retailers, which are likely to increase clothing prices anywhere from 5 percent to 20 percent after holding steady for about two decades.
  • Kimberly-Clark (KMB) said Monday that it plans to raise prices, its third such announcement since the middle of March.

To me, those data points are meaningful because they not only reinforce the notion of inflation, but also make me wonder how long it will be until other restaurants and apparel makers begin implementing price increases? The next logical question is how long until this is felt in the Consumer Price Index (CPI)? Bear in mind, for the last 12 months headline CPI is up 2.7 percent before seasonal adjustments according to the U.S. Bureau of Labor Statistics.

Despite the corporate earnings beats, what I find more worrisome near-term is the lack of real wage growth, the negative trend in inflation adjusted disposable income and a 19.3 percent underemployment reading per recent Gallup data – all at a time when all of the major stock market indices are at or near three-year highs. In my view, there is increasing risk to the consumer and consumer spending and whether or not improved corporate spending can offset what may turn out to be weaker than expected consumer spending in the coming weeks and months. Better-than-expected earnings this week by several major technology vendors, such as Intel (NASDAQ:INTC), IBM (NYSE:IBM), EMC Corp. (NYSE:EMC) and VMware (NYSE:VMW), suggest a rebound is underway in corporate IT spending, but consumer spending accounts for the lion's share of our economy.

Stay tuned as we hear from more companies this week.

Source: March Quarter Earnings Beats vs. Concerns in Corporate Outlooks