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David Moenning is a the proprietor of StateoftheMarkets.com. In addition to providing free and subscription-based portfolios on "State", Dave is a full-time money manager and the President and Chief Investment Strategist of a Chicago-based Registered Investment Advisory firm. Dave... More
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Daily State of the Markets
  • What To Expect From The Earnings Parade 0 comments
    Jan 9, 2013 8:16 AM

    Daily State of the Markets
    Wednesday, January 9, 2013

    Good morning. Well, it's that time of year again - earnings season. If you've been at this game for any length of time, you know that this is where things really get interesting. This is where the rubber meets the road, where the estimates meet with reality (oops, I mean where the highly paid analyst guess work meets with reality), and where themes develop for companies, sectors, and the market as a whole.

    This is also where the algorithms that control the vast majority of trading in the market take over and logic oftentimes goes out the window (although, in reality, conventional logic rarely has much to do with the stock market). For example, companies that beat analysts' expectations in terms of earnings per share (NYSEARCA:EPS) but miss the consensus estimate for their revenues - or say something conservative about the future - are likely to get hammered. And on the other hand, should a company produce a "triple play" by beating EPS and revenue expectations, and then increasing their "guidance" (the company's own internal guesswork relating to future earnings) for the upcoming quarter, the stock will be handsomely rewarded.

    Especially at this time of year, it is important to remember that this game is all about expectations versus reality. So, while it does indeed sound silly that stocks will react violently to a report that doesn't match expectations - even though the analyst estimates that the report is being compared to are rarely, if ever, accurate - this is the reality of the earnings game. And what's worse, the bottom line is that "reality" tends to be a moving target in this business.

    My primary point this morning is that it is important for investors to understand what the game is about during earnings season. Investors first need to know what is generally expected of the earnings parade before it begins. And then they also need to be able to keep score of how the earnings season is progressing. As usual, we will do our best to assist on both counts.

    Over the past two quarters, the trend of the earnings season has emerged early and has been unmistakable. In sum, companies have done a pretty decent job of beating expectations on the "bottom line" (EPS) but have consistently missed on the "top line" (revenues). The key here is to understand that companies can play all kinds of games in order to financially engineer a "beat" in terms of their EPS number, but revenues are tougher to mess with.

    This theme of companies consistently missing revenue numbers helped confirm the idea that the economy was slowing this summer/fall. But with the focus lately having been on the election and all the fiscal cliff nonsense, it will be interesting to see if the "revenue light" theme persists again this quarter. Alcoa kicked things off yesterday with a report that was the exact opposite of this theme - AA missed EPS by a penny but beat revenues handily. The company also said that things were looking up in China. And should this theme be reinforced in the coming weeks, it is a safe bet that the indices will enjoy a nice ride higher.

    Looking At The Numbers

    So, since the earnings parade doesn't really get rolling until next week, I thought it would be a good idea to spend a couple minutes exploring the expectations for the current earnings season. So let's get to it. According to FactSet, the S&P 500 EPS estimate currently stands at $25.47 for the 4th quarter. This would represent an increase of 2.4% for the quarter, which isn't exactly robust. In addition, this estimate is down from the 9.2% growth rate that was expected at the start of the quarter. In other words, the expectations for EPS growth have fallen dramatically over the last three months.

    In terms of the revenue growth expectations, the FactSet estimate is for 2.1% in Q4. This is down from the 2.7% growth rate that the firm had on September 30th. This occurred because, according to FactSet, 78 companies issued negative EPS guidance for Q4 during the pre-announcement period, while only 32 issued positive EPS guidance. This means that 71% of the companies warned that earnings would be below current expectations. This is about ten points above the five-year average, but also below the 78% negative guidance rate seen last quarter. FactSet also points out that the reason behind the declining outlook is simple: the lingering macro overhang relating to the economy and global growth.

    Because of all this, I will be watching the upcoming earnings parade with particular interest. My goal will be to try and determine if the much ballyhooed "uncertainty" surrounding the fiscal cliff, the talk of delayed capital investment and hiring, the slowdown in Europe, and the effects of Superstorm Sandy will actually show up in the numbers. Most analysts expect to hear a lot of excuses and to see a rather punk parade. But, I'm going to withhold judgment for now and see what I see as the numbers roll in.

    Publishing Note: I am traveling for the remainder of the week will not publish a report. Daily State of the Markets reports will return on Monday.

    Turning to this morning... Things are fairly quiet again this morning. Overnight markets were modestly higher as Alcoa's comments about China being on the comeback trail helped buoy the mood. There are no economic inputs to guide traders today and no major earnings reports. U.S. futures are currently pointing to a modestly higher open on Wall Street.

    Pre-Game Indicators

    Here are the Pre-Market indicators we review each morning before the opening bell...

    Major Foreign Markets:
    - Shanghai: -0.05%
    - Hong Kong: +0.46%
    - Japan: +0.68%
    - France: +0.06%
    - Germany: +0.05%
    - Italy: +1.20%
    - Spain: +0.49%
    - London: +0.39%

    Crude Oil Futures: -$0.10 to $93.05

    Gold: -$2.30 to $1659.90

    Dollar: lower against the yen, higher vs. euro and pound

    10-Year Bond Yield: Currently trading at 1.879%

    Stock Futures Ahead of Open in U.S. (relative to fair value):
    - S&P 500: +3.30
    - Dow Jones Industrial Average: +28
    - NASDAQ Composite: +4.28

    Thought for the day: Find the good. It's all around you. Find it, showcase it & you'll start believing in it. -Jesse Owens

    Positions in stocks mentioned: none

    Follow Me on Twitter: @StateDave

    In his latest video presentation, Dave M. walks you through the New "Adaptive" Active Risk Management System for the Stock Market


    The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report and on our website is for informational purposes only. No part of the material presented in this report or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program. The opinions and forecasts expressed are those of the editors of StateoftheMarkets.com and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. One should always consult an investment professional before making any investment.

    Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.

    The analysis provided is based on both technical and fundamental research and is provided "as is" without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

    The information contained in this report is provided by Ridge Publishing Co. Inc. (Ridge). One of the principals of Ridge, Mr. David Moenning, is also President and majority shareholder of Heritage Capital Management, Inc. (NASDAQ:HCM) a Chicago-based money management firm. HCM is registered as an investment adviser. HCM also serves as a sub-advisor to other investment advisory firms. Ridge is a publisher and has not registered as an investment adviser. Neither HCM nor Ridge is registered as a broker-dealer.

    Employees and affiliates of HCM and Ridge may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Editors will indicate whether they or HCM has a position in stocks or other securities mentioned in any publication. The disclosures will be accurate as of the time of publication and may change thereafter without notice.

    Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.

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