1. Earnings 2. Reaction 3. Guidance

Once again Barry Ritholtz provides some timely information on market conditions, with a look at the current earnings season.  The chart showing the stock price reactions is most informative.  Barry’s explanation, however, is not very persuasive.  First take a look at his data:

Link: 1. Earnings 2. Reaction 3. Guidance.

We are about halfway through earnings season, and it looks like another quarter of double digit year-over-year earnings growth. This now makes something like 14Qs in a row. That’s the good news. To a large degree the market has already priced in these …

Barry looks at the market reaction and sees evidence that things will get worse.  He points to the guidance that companies provide as confirming this idea.

Here’s the real story.

Look at the other two worst quarters judged by stock price reaction after the report: Q1 05 and Q2 04.  I remember both of them well, and the pattern is familiar:

  • Analysts covering individual stocks of a cyclical character have been trying to call an economic top for 2 1/2 years. They have been completely wrong about stocks like Caterpillar, Ingersoll Rand, materials stocks, and many others.
  • Market "strategists" have been looking for a recession in every data point since the election-year debates over employment growth.  They have been completely wrong in predictions about consumer and business spending.
  • Rookie hedge fund managers, overly-influenced by the 1999-2000 bubble years, are eager to be contrarian.  They want to be the first to spot a market decline.  They have also been wrong.

You can see this by looking at the actual market reaction to corporate guidance.  When CAT executives say that business is great, global prospects are excellent, and they are only midway through a growth cycle, their report is viewed with skepticism.  Some firms even raise earnings estimates while lowering price targets.

Barry calls this the cycle of multiple compression.  I say it is trying to guess the top — and doing it without good evidence.

When guidance is less than perfect, you get something like the UPS fiasco.  A company adjusts guidance based on  consensus economic forecasts and the market interprets this as evidence that the consensus forecasts are too high!

The skepticism toward both analysts and reporting companies is excessive.  It has been wrong for several years now.  This Wall Street error provides an opportunity for investors who have confidence that the fundamentals matter.

You may also like


  • Barry Ritholtz July 27, 2006  

    You say skepticism is excessive —
    I say its a sign that there is nowhere near the level of negative sentiment that is required for a firm botttom.
    Remember, sentiment is a contrary indicator only at extremes . . .

  • Jeff Miller July 27, 2006  

    Barry — I’m not referring to sentiment here, at least not in the sense you measure it. I am talking about people like you and me doing our jobs — that means actually listening to the conference calls or reading transcripts. The problem is that many people shoot from the hip based upon someone else’s summary. Some firms downgraded UPS before the opening, so they could get the $80 price on the report, even though their customers could not sell at that price.
    I have watched CEO interviews and read analyst reports and listened to conference calls for 20 years. I have NEVER seen such skepticism by those responsible for other people’s money. We should be doing our best to find the facts. It is both reckless and foolish to assume that analysts and executives are always lying. It is also a money-losing strategy.