Weighing the Week Ahead: Earnings Season

Once again, it is time to focus on corporate earnings reports.  For more than a year there has been a chorus of skepticism about earnings.  Here are some typical assertions:

  • Earnings cannot be sustained in a period of slow economic growth.
  • Strong earnings gains are impossible without the consumer.
  • Earnings growth through cost-cutting cannot be maintained.
  • And variations on these themes….

It is important to recognize that these predictions have all been proven wrong — repeatedly, for more than a year.  The stock market performance has dramatically lagged the strong earnings growth, resulting in ever-lower P/E multiples on both and forward earnings.

Meanwhile, there is continuing economic growth, an increase in consumer spending, and an increase in revenue.  This is all happening despite continuing high unemployment.

Evaluating earnings season should be done against this backdrop.  Before doing so, let us do a review of last week’s events.

Background on “Weighing the Week Ahead”

There are many good services that do a complete list of every event for the upcoming week, so that is not my mission.  Instead, I try to single out what will be most important in the coming week.  If I am correct, my theme for the week is what we will be watching on TV and reading in the mainstream media.  It is a focus on what I think is important for my trading and client portfolios.


Last Week’s Data

The most important new data for last week was the employment report.  Our forecast was for a loss of 110,000 jobs, one of the most accurate public predictions.

The Good

  • Market action.  The market has adopted a “Don’t fight the Fed” mode, where participants think that economic weakness will be the target of aggressive action.
  •  The ECRI indicators improved yet again.  In April I explained about misleading interpretations of the ECRI index.  In June, I updated the analysis.  There are several sources who, despite not knowing the makeup of the ECRI index, use it to forecast a recession.  One of them even sees a 100% chance.  Another has the most widely-cited fancy graphs in the investment blogosphere — without ever citing what the ECRI says about interpreting their own data.  For the record, the official ECRI interpretation is still in limbo — slowing growth (aka ‘soft landing’) versus another recession.  Here is a nice video discussing the ECRI readings in the context of the jobs report.  If you really want to understand what is going on, take five minutes and watch it.
  • The DJIA had a Golden Cross, the 50-day moving average crossing the 200-day.  We will probably also soon see a Golden Cross in the S&P 500.  My summer interns are back in college, but someone should do the research.  How many of those sources that trumpeted warnings about the Death Cross, the Head-and-Shoulders, and the Hindenburg Omen are now writing about the Golden Cross, the Upside Down head-and-shoulders, and the failure of the Omen?

The Bad

The bad news this week is all about employment.  Many observers of the perma-bull persuasion tried to emphasize the growth in private payrolls in the most recent employment report.  They were joined by bearish brethren who celebrated the loss of government jobs.

Both viewpoints are incorrect.  Government services are an important part of the US economy.  We all use and consume the work of teachers, firefighters, police, military, social security administrators, government health professionals, and many others.

It is both facile and deceptive to dismiss government jobs as worthless.  Whether viewed in terms of services provided or employing workers, a job is a job.  Even though the loss of nearly 100K jobs reflected government cutbacks, the loss is very real.  Extended unemployment also worsened.

We are very far from what is needed — a growth of nearly 150K jobs per month to absorb new entrants to the market, and much higher to reduce unemployment.  This was a poor jobs report.

Unnoticed by most was the preliminary estimate of benchmark revisions.  The BLS checks its monthly report against actual data from state reports and does an annual benchmarking process.  This is an honest and effective way to check the actual estimates.  The estimated revisions suggest that employment gains have been over-estimated by about 30K per month.  This brings the reports closer to our own monthly forecasts.  It is not good news, but the change is much lower than the 1 million plus adjustment we saw last year.  (I expect to review this more carefully.)


The Confusing:  Bogus Opinions about Quantitative Easing

I have a simple proposal that would save everyone a lot of time.  Before anyone is allowed to pontificate about the merits of quantitative easing, the pundit would have to demonstrate a minimal level of knowledge.  Let us try the following:

In three sentences, please explain what quantitative easing is, how it is implemented, and what it is intended to accomplish.  (n.b., slogans like “printing money” do not constitute an acceptable answer.)

This would probably eliminate nearly everyone, and confront CNBC with a major problem.  How would they do any interviews if they could not ask people questions about things where they had no knowledge?

Meanwhile, the market continues to trade on expectations for Fed action, a policy which hardly anyone understands.

The Week Ahead

This week is about earnings.  I am not very interested in the inflation data.  It will be unimportant unless there is a major upward spike.  Some will see a decline in the core rate as evidence for more quantitative easing.  Some will also look to the Fed minutes, but again I expect very little.  I am always interested in the weekly jobless claims, but we have several weeks before the next employment report.

The most important news will be about earnings.  This earnings season starts with the market at the high end of the recent trading range and the P/E ratio very low.

If “good news is good news” the market can break out to much higher levels.  I expect every report to be tested in several ways:

  • Results versus the expectations, including the whisper number;
  • Whether revenue met expectations;
  • Changes in future guidance:
  • Comments on the economic environment.

The difficulty in meeting all of these tests, in the face of intense skepticism, helps to explain the P/E multiples.  The first reports will give a hint about the market reaction.

A Good Question

Most people are skeptical of earnings estimates, arguing that they are too optimistic.  Despite this, companies beat estimates by a ratio of better than 2-1.  What is the explanation?

The first reports will give a hint about whether the market will compress P/E multiples even further.  If not, the market could move much higher on strong reports.

Our Own Forecast

As we have been for most of the recent rally, we remain bullish.  With few sectors in the penalty box, there are more attractive ETF choices in addition to many low P/E stocks with good yields.  We continue our multi-week bullish posture in the weekly Ticker Sense Blogger Sentiment Poll.   Here is what we see:

  •  87% of our 55 ETF’s have a positive rating, up from 95% two weeks ago.
  • Only 9% of our 55 sectors are in our “penalty box,” down dramatically from 80% last week.  This means that there are many attractive sector and stock opportunities.
  • Our universe has a median strength of +25, down slightly from +32 two weeks ago.

For trading accounts, we had full exposure during the past week.

[For more on the penalty box see this article.  For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly email list.  You can also write personally to me with questions or comments, and I’ll do my best to answer.]


The market has continued to improve in tone.  I am going to repeat the conclusion from two weeks ago.

The market moved closer to a viewpoint we have espoused for the last several weeks.  It had several voices, including this one:

“The concept of a double-dip recession has been replaced with slow and steady improvement, and even if we don’t get it, we have a Federal Reserve that’s ready to step in and support the rally,” said Art Hogan, chief market analyst at Jefferies.

The futures got a big pop Friday morning after a similar statement from David Tepper.  For me, this was hardly fresh news, but it is nice to see people joining in.

I continue to see a bullish environment for both traders and investors, and our accounts reflect this.

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  • Al Brockman October 11, 2010  

    You state:Government services are an important part of the US economy. We all use and consume the work of teachers, firefighters, police, military, social security administrators, government health professionals, and many others.
    You miss the point.Yes, the services are necessary but not at the present cost. Many government workers’ unions have priced their members’ services at outrageous levels. Take a look at teachers – their working hours; their pensions; their benefits. There are many ways to provide the same services at lower costs. I administered public sector contracts for 30 years and know whereof I speak. There are so many ways to reduce the cost of public education, i don’t even know where to start. Just a simple example – increase class size from 20 to 22 and you immediately reduce teacher salary and benefit costs by about 10 percent! And the impact on children is between minimal and zero.
    The same thing goes for public works, police and fire and all the other “necessary” public services.

  • Verge October 13, 2010  

    This does not sound right : ” 87% of our 55 ETF’s have a positive rating, up from 95% two weeks ago.” Or am I missing something?

  • oldprof October 13, 2010  

    Al – I understand your viewpoint on dealing with wasteful spending, but I didn’t really miss this point. I just don’t like to take up political arguments. I am trying to evaluate the level of economic growth by looking at employment. For that purpose, a government job counts.
    I hope you understand my approach.

  • oldprof October 13, 2010  

    Verge — Good point. I should have said “down slightly” since the numeric values are accurate.
    Thanks for catching this.

  • Mike C October 13, 2010  

    In three sentences, please explain what quantitative easing is, how it is implemented, and what it is intended to accomplish. (n.b., slogans like “printing money” do not constitute an acceptable answer.)
    I’m going to cheat 🙂 :
    Richard W. Fisher
    When the Federal Reserve buys Treasuries to drive down yields, it adds money to the financial system. In sharp contrast to the depths of the Panic of 2008, when liquidity had evaporated and we stepped into the breach to revive it, today there is abundant liquidity in our economy. The excess reserves of private banks parked at the 12 Federal Reserve Banks exceed $1 trillion. Nonfinancial corporations have an aggregate liquid asset ratio running at a seven-year high; cash flow from current production is running above total investment expenditure; cash as a percentage of market cap is extraordinarily high. Credit availability remains a challenge for small businesses, but only 4 percent of small businesses surveyed by the National Federation of Independent Business reported financing as their top business problem.[4] And reports of lagging receivables or the stretching out of payment terms that were so prominent only one year ago in the corporate supply chain have become as scarce as hens’ teeth.
    The vexing question is: Why isn’t this liquidity being utilized to hire new workers and reduce unemployment? Why is it that, as pointed out in Alan Greenspan’s op-ed in this morning’s Financial Times, the share of liquid cash flow allocated to long-term fixed asset investment has fallen to its lowest level in the 58 years for which data are available?[5] If current dramatically high levels of liquidity and low interest rates are not being harnessed to add to payrolls or expand capital expenditures, would driving interest rates further down and adding further liquidity to the system through Fed purchases of Treasury securities induce U.S. businesses and consumers to get on with spending it?
    So, it is indeed true that some economic theories would lead one to believe we can shake job creation from the trees if we were to further expand our balance sheet. Yet, to paraphrase the early 20th century progressive, Clarence Day―the once ubiquitous contributor to my favorite magazine, The New Yorker, and author of one of my all-time favorite films, Life with Father―“Too many (theorists) begin with a dislike of reality.”[6] The reality of fiscal and regulatory policy inhibiting the transmission mechanism of monetary policy is most definitely present and is vexing to monetary policy makers. It is indisputably a significant factor holding back the economic recovery.
    n performing a cost/benefit analysis of a possible QE2, we will need to bear in mind that one cost that has already been incurred in the process of running an easy money policy has been to drive down the returns earned by savers, especially those who do not have the means or sophistication or the demographic profile to place their money at risk further out in the yield curve or who are wary of the inherent risk of stocks. A great many baby boomers or older cohorts who played by the rules, saved their money and have migrated over time, as prudent investment counselors advise, to short- to intermediate-dated, fixed-income instruments, are earning extremely low nominal and real returns on their savings.

    I continue to hold a sizable profitable position in gold.

  • Mike C October 15, 2010  

    Regarding quantitative easing, I’m going to modify/supplement my answer, but I am still going to cheat and copy the smart kid’s homework:
    Thomas Hoenig, the president of the Federal Reserve Bank of Kansas, on Tuesday launched his most strident attack yet against QE, arguing it would not help drive an economic recovery.
    “There is simply no evidence the additional liquidity would be particularly effective in spurring new investment, accelerating consumption, or cushioning or accelerating the deleveraging that is hopefully winding down,” Mr. Hoenig told an audience in Denver.

  • oldprof October 15, 2010  

    Mike C. — The point of my article was a familiar theme for me: Most people have a strong opinion without really understanding the issue.
    Does quoting someone at length provide more insight on this argument? I don’t know.
    Meanwhile, if you are going to quote the opinions of those on the Fed, I am curious about why you are going for the dissenters?
    As you know, I like to predict what the Fed will do. It is the profitable way to go. Do you think you have an edge by going with the minority?
    Just curious…