Earnings Update

Includes: SPY
by: Alhambra Investment Partners

By Margarita Fernandez

To him who is in fear, everything rustles." - Sophocles

Smart philosopher, Sophocles and although he wasn't referring to investors, a better description for today's market participants is hard to find. Nervousness and plain old fear seem to have relegated the financial markets to short-term, news-driven schizophrenic behavior. It is visible in the bond markets, commodity markets and, of course, almost without exception, across global equity markets. It is a flashback to the days of risk-on/risk-off, flip a coin, "what day is it?" mentality that we saw during and following the Great Recession. A truly difficult environment for long-term investors to keep their eyes on the prize.

The S&P 500 is essentially back to where it stood last August, while "safe" assets such as gold and U.S. government bonds have rallied. The media bombards us daily with viewpoints from economists and market pundits in differing camps, those that are adamant that we are in a Bear market (the bull is dead!) and others equally confident that we are correcting in a long-term Bull market (long live the bull!). It is heartening to see from time-to-time, well-known investors and strategists from Wall Street that humbly put forth the theory that no one knows where the economy, nor the financial markets will be in the next six months, much less at year end. There are a multitude of unknowns, interrelated yet conflicting issues that combined, present quite a puzzle as to how this will all balance out six to twelve months down the road.

There is an economic slowdown in many parts of the world - especially (but not limited to) commodity-driven economies in the emerging markets space. The U.S., however, appears to continue meandering on in the 1.5%-2% annual growth rate. Not very inspiring, but not a contraction either. Can this continue with a manufacturing sector in recession and a thriftier American consumer? Maybe, possibly. Following lackluster sales in December, January core retail sales picked up 0.6%. Core retail sales exclude autos, gas, building materials and food services and is purported to be a better indicator of the consumer spending component of GDP. The December Job Opportunities and Labor Turnover Survey (JOLTS) indicated 5.6 million job openings, the second highest on record. Also positive were signs that employees were willing to change positions/employers, possibly reflecting more confidence in the job market. A tighter labor market could serve to push up wages, put more money in the hands of consumers and assist in offsetting some of the deflationary pressures from the sharp decline in oil. There has been some speculation that a portion of U.S. consumers have become more diligent savers, in order to attain home ownership. The percentage of down payment required for a home purchase is much higher now and first-time buyers and those who switched from owner to renter in the recession must overcome this greater hurdle. This would be an additional positive for housing, which has been plugging along, as well as, all the related industries and employment. If consumers are more willing to spend, they create a circular reference of sorts.

Many central banks, such as Sweden and Japan, each with directives for the state of their particular economies are at odds with the U.S. Federal Reserve's current (as far as we know) tightening bias for interest rates. Trying to determine the net results of the consequences of these actions is head spinning work. All the counter-balancing effects: the flow of funds between countries as investments move around the world looking for higher risk-adjusted returns, fluctuations in currency parities, effects on (export/import) trade balances, etc. These are only a portion of the intertwining ball of yarn that is globalization today. And let me forgo commenting on the negative rates discussion for the U.S. that has been bandied about recently. I will point out that yields have moved in the opposite direction anticipated since the first hike by the Fed. The Treasury yield curve has shifted down across all maturities. Most people realize that fiscal policy needs to step up, but it is difficult to see how this would be accomplished in an election year.

So what is the end game for the U.S.? How much insulation does corporate America have from the slowdown in China, the vagaries of OPEC, the dysfunction of the U.S. politico, physical and cyber terrorism and currency manipulation? How resilient is the U.S. economy following the debt crisis, the great recession and quantitative easing 1,2,3…? It appears that the credit and stock markets are saying, in a rather excruciating way, that things are extremely uncertain. As we know, the financial markets do not appreciate uncertainty. There is also the anticipatory nature of the markets, which may be warning that things are looking unhealthy. Crystal balls are murky, and keep in mind that investors often overshoot to the upside and the downside in the short run.

Earnings season is on-going and has been a mixed bag with some disappointments and much negative guidance. S&P Capital IQ estimates that for the fourth quarter the S&P 500 Index companies will have reported a 5.24% decline in year/year earnings per share. Only three of the ten Economic Sectors of the Index are expected to show positive EPS growth. The highest EPS growth is projected for Telecom which has had some consolidation activity (the AT&T (NYSE:T) purchase of Direct TV for example). Second is Consumer Discretionary which includes the heavy hitter Amazon (NASDAQ:AMZN), which disappointed for the quarter but had strong year/year earnings expansion nonetheless. Health Care is forecast to also have positive year-over-year comparisons, partially due to mergers and acquisitions but also organic growth.

Alhambra continues to emphasize a minimum 50% fixed income allocation for balanced portfolios - with a magnifying glass approach to individual security selection. Since we are not day traders, but long-term investors; we believe that a higher allocation to fixed income and cash reserves is warranted at this time when considering a risk/reward trade-off. Alternately, no one can consistently and correctly time the market in the short term - there really is no bell ringing before stocks begin to move up again. Therefore, for patient investors that are looking for growth, equity investments should continue to have a place in your balanced accounts.