If there is a common theme we are seeing in second-quarter earnings reports, it's the adverse impact the stronger dollar and the weaker global economy are having. Many companies are blaming both for dampening profits.
The slowing economy is curtailing spending. Earlier this week, truck manufacturer Paccar (NASDAQ:PCAR) said its customers are choosing to hold onto aging trucks for a longer period of time, rather than replace them. The stronger dollar is hurting companies ranging from PepsiCo (NYSE:PEP) to United Technologies (NYSE:UTX). My colleague Wayne Thorp and I both feel like each earnings report we look at has a profit number that has been adjusted to offset the impact of currency translation.
Despite this, second-quarter earnings are coming in better than forecasts. As of Thursday morning, Thomson Reuters I/B/E/S calculates that out of the 260 S&P 500 to report so far, 67% have topped expectations, while just 22% have missed. Historically, 62% of companies beat estimates and 20% miss.
Unfortunately, the second-quarter numbers that topped estimates need a big asterisk by them. Brokerage analysts reduced their earnings forecasts throughout the second quarter and evidently lowered the bar enough. (At the start of April, Thomson Reuters I/B/E/S' consensus estimate called for 9.2% growth in second-quarter profits; today, the blended forecast of reported numbers and current forecasts calls for just 6.1% growth. S&P Capital IQ's numbers, which are adjusted and currently signal a decline of 0.65%, have also been revised downward over the past few months.)
Revenues don't look great when compared to expectations either. Thomson Reuters says only 41% of reported companies topped projections, while 59% reported disappointing sales numbers.
One of things the market does have going for itself is a cheap valuation. The S&P 500 is trading at 13.2 times trailing 12-month earnings and 12.3 times I/B/E/S' projected profits. Using S&P Capital IQ's numbers instead gives us a trailing price-earnings ratio of 13.3 and a forward price-earnings ratio of 12.7. The earnings yield of 7.4% also favors stocks, especially when compared to the extraordinarily low yield of 1.43% for the 10-year Treasury note.
Could stocks get cheaper? Unfortunately, yes. But by staying out of the market right now, you are also risking the possibility that stock prices will actually rise over the next several months. Catalysts for such an increase would not only include expectations for some type of agreement out of Washington on the budget and taxes, but also actions by the Federal Reserve and the European Central Bank (ECB).
There continues to be expectations that the Federal Open Market Committee will announce a new round of quantitative easing. The timing of the so-called QE3-we're on a modified version QE2 right now-is unknown, but it could happen before the election. ECB president Mario Draghi proclaimed Thursday morning, "Within our mandate, the ECB is ready to do whatever it takes to preserve the euro." I won't speculate on what the ECB will or won't do, especially since headlines from across the Atlantic continue to feel like they've been recycled. I will remind you, however, that alongside all of the fear and skepticism that existed in 2008 and early 2009, there was also a lot of chatter and pronouncements from central banks and government officials. What there wasn't, however, was a big, flashing billboard telling you that Mr. Market changed his mind and became convinced that the financial system was not going to fall into the abyss.
We never know that a bottom is being set until we're past it, and false market bottoms have been set before. But, just as there is a risk of further price declines, there is also the risk of missing out on potential gains. As I commonly tell members who ask whether now is a good time to invest or not, we're in a situation where things could go very wrong, but could also go very right.
Disclosure: PEP and UTX are held in the AAII Dividend Investing portfolio. Charles Rotblut, the author of this article, does not hold personally own either stock.