Earnings Update

by: Alhambra Investment Partners

By Margarita V. Fernandez

"Patience is the ability to idle your motor when you feel like stripping your gears."

- Barbara Johnson, Author

After a swift decline in January, a flat February, a strong turnaround in March and a pretty flat April, investor patience is starting to wear thin. It seems ever more difficult to discern a direction for the markets and the economy. As Joe Calhoun has remarked in his recent writings, the indicators our firm utilizes to analyze expectations on the health of the US economy have been mixed, and official economic data releases have also been contradictory (as you can see here in our Bi-Weekly Economic Review). Political uncertainty is not confined to the upcoming US elections; Brazil impeached their president last week, and an immigration crisis is stirring extremism across Europe. Not a surprise, then, that financial markets wander aimlessly as participants wait for a resolution one way or the other.

As earnings season begins to wind down, quarter-to-date returns for US stocks have been lackluster, with the S&P 500 and Dow up 0.46% and 0.52% respectively through May 12th. Although we've seen a majority of companies (approximately 72%) posting positive earnings surprises, that is against estimates that were lowered substantially by the end of the first quarter. It has been harder for companies to beat on revenues, but according to FactSet, 55% of companies have managed the feat. Thomson Reuters' data shows first-quarter earnings down, year over year, by approximately 5%.

Focusing the Earnings Update report on the consumer discretionary space this time around seems rather appropriate, as retailers have been in the news daily this week, and they comprise the greatest weighting in the sector - over 40%. Consumer Discretionary proved a winning sector last year, returning over 10% versus the S&P 500's total return of 1.38%. This year, the stocks are up (through 4/29/16), but have lagged most other sectors, with the exception of Financials, Healthcare and Technology. Earnings released by some of the largest retailers this past week - Macy's (NYSE:M), Nordstrom (JWM), Kohl's (NYSE:KSS), and Dillard's (NYSE:DDS) - did nothing to improve the performance of the sector, as all four (and others) saw their stock prices decline precipitously. Earnings and revenues were dismal, and forward guidance pretty pessimistic. Earnings and sales didn't just miss lowered expectations - they are declining outright, and inventories continue to run high. Betting against the American consumer has always been a loser, but 2.5% year-over-year wage growth has us in a stingy mood, lower prices at the pump notwithstanding.

So, in an effort to find a silver lining (it helps to be an optimist when you manage money), let's consider a couple of noteworthy economic releases today. The University of Michigan Consumer Sentiment Index for April was much stronger than expected at 95.8, versus last month's 89 and a consensus of 90. The April retail sales report was another bright spot, up 1.3% in April (relative to March) to a seasonally adjusted $453.44 billion. A look at the details shows strength in autos, gasoline and non-store retailers. Autos sales rebounded strongly, up 3.2% after a weak March, and higher prices helped gas station sales. In the non-store category is Amazon (NASDAQ:AMZN), one giant non-store retailer that reported earnings and revenues well ahead of expectations and saw a 10% stock price pop after the announcement. Cost-conscious consumers continue to respond to the convenience and lower-priced offerings of e-commerce. Although the traditional retailers have an online presence, they continue to struggle to compete with Amazon and some of the other e-commerce sites that are relatively unburdened by the cost of maintaining a physical presence. Amazon, for now at least, appears to be eating most everyone's lunch. In retail, investors face a textbook value versus growth decision. Traditional retailers are certainly cheap but lack growth, while Amazon has growth but a fancy stock price to match.

The value versus growth emphasis shifted this past quarter. Last year, growth stocks were the definitive winners, while so far this year, the reverse has been true (despite the retail exception). We have seen considerable outperformance in yield stocks, a subset of the value strategy. With Fed rate hikes getting pushed out - maybe to next year - income investors have bid up dividend payers to prices that probably put their "safe" reputation at risk. It may be time to trim some of those winners. Consider your personal risk parameters and time horizons in looking for less well-liked replacements with quality characteristics. Adding some cheaper international stocks to your conservative equity portfolio probably makes sense here, too, with dollar strength waning. Diversification and patience are best friends when it comes to managing risk. Now that all boats are no longer rising with the tide, it's an important time to be vigilant and to do your homework... or have a professional do it for you.