Markets Make It Out Of The Pullback By Riding The Earnings Wave

by: Jonathan Novinski

Market Look Back and Outlook

Well the market finally had its consolidation period. I called it extremely early this time, kind of making me feel like the Royals, wondering if I was playing the wrong game. Luckily that feeling has changed!

We saw the market consolidate from the fourth to the 25th of April. Recall the news at the beginning was all about Europe, especially Spain, but with strong earnings we were able to break the clutches of the European crisis. Could the earnings wave we've been riding be getting close to hitting shore though? This is a somewhat hard question to answer. The only earnings news you ever really hear about is from big companies like Apple (NASDAQ:AAPL), which is growing like mad. Sure it's good to know how big companies are doing, since they can help gauge the economy's health, but in reality the large-cap stocks earnings don't matter (unless you own them or a company in the same industry) when we are trying to find out the overall strength of earnings growth. Why? There are 30 stocks in the Dow Jones; these are large-cap big names. The main index for small-cap to mid-cap stocks has 2000 (Russell 2000 - IWM). If a company the size of Microsoft (NASDAQ:MSFT) is having difficulty, it doesn't mean every software company will do bad, and it shouldn't be a reason to think that the entire quarter will be bad for stocks. I can't count how many times I've heard, "Everybody get a life jacket because Alcoa (NYSE:AA) didn't do amazing and that means we will have a bad quarter!" It is fine to hear what big companies have to say, in fact I encourage listening to them, but they don't decide the fate of an entire quarter even if they move the market on the day they report.

You may remember 2010. Almost any company reporting was beating estimates, making money, and guiding higher. The world economy didn't seem as stagnant as people thought. The market was doing well other than a couple of pullbacks. The S&P ended the year up 11%. 2011 earnings were fine, still pretty good, but we had Europe toss us around. S&P ended the year basically flat. 2012? Earnings have been, well not too exciting; of course with the exception of a few blow outs, but you always have those. Granted companies are still growing, which is a nice positive, but there will come a point when Europe will come back, and the earnings that are slowly losing excitement will not be able to send this market higher.

Europe, like Rocky Balboa, is down, but not even close to being out. This leaves businesses in an indecisive state, just like our policy makers. Unless we can see a clear message from D.C. or a nice pick up in China, I don't see this ending nicely. You will always have those companies that grow, but the focus becomes whether or not the market is growing as a whole. That growth we've had has lost steam, and this past earnings season overall didn't help to greatly increase it.

Game Plan

The market won't be straight up, and won't be straight down. Expect a lot of volatility especially in the third quarter, as historically that has been the time for market craziness. I would love to sit here and write on and on about trading and using strong stocks in strong industries, but I know most people don't have the time to do that. It just isn't possible to keep up with all the stocks, the market, and still do what you need to do every day a lot of the times. As a full-time student I limit myself to only trading in the summer when I'm off.

We can't not be in the market either; it's one of the best financial markets to make money in. So here is what I recommend doing. I'm a dividend guy, a lot of you know that, but I'm also a guy who can't get away from the growth stocks that make you nice money. When picking out growth stocks in this market though, we need to be careful. I recommend sticking with good names we know. Look at Starbucks (NASDAQ:SBUX). It should hold up well during a market correction, and has pulled back a little from its high. It may not being growing like crazy, but it has many products in the pipeline, plus room to expand globally is there. Look at some of the retail names, not only discount retailers such as Dollar General (NYSE:DG), but also names like Macy's (NYSE:M), VF Corp (NYSE:VFC), and Dillard's (NYSE:DDS). Slowly, but surely the consumer is coming back, and these companies are set up very nicely. We saw O'Reilly rally big, leading the auto group higher. I like a few names in this group: Advanced Auto Parts (NYSE:AAP), AutoZone (NYSE:AZO), and Lithia Motors (NYSE:LAD). In an economy where people are trying to save a little, they are a lot more likely to try to fix their car or buy a used car than go after brand new.

Names like these should work great with your dividend stocks. These companies provide a nice balance of growth, and a chart that has decent technical strength should things get nasty. Besides, when things start to look a little gray, buy a long put so you can protect yourself if your stock falls in a harsh pull back.


The market has consolidated and is riding the earnings wave, but as a surfer we need to watch out for the Great European shark that's lurking. Stay in safe dividend stocks, and any growth you go after should be names you know, and are sound fundamentally and technically. McDonald's (NYSE:MCD) is another good example. If you fear the shark may bite, you can sell your position or buy a long put. I use the latter, because it can provide a lot better flexibility.

The market and company earnings aren't what they used to be and Europe is still having problems. Earnings will only hold us so long before we have to face the facts.

Disclosure: I am long LAD, SBUX.