Weighing the Week Ahead: Time for Earnings

Most of the investment world will focus on earnings next week. That will drive the markets.  For others, the earnings story is utterly irrelevant since there is too much to  worry about.  It is a sharp contrast.

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 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.  So far, my focus has been pretty good, including last week’s Fed Fixation piece.

What about Earnings?

When it comes to earnings, the investment world is sharply divided.  There is a great divide about earnings and market valuation.  Over a year ago, right at the market bottom, I wrote an article reviewing the various approaches to valuation and explaining why they would be no help.  You needed to step away from backward-looking methods.

A Small (but humorous) Digression

The earnings debate reminded me of an article from decades ago.  One of my favorite sportswriters, Pete Axthelm, wrote for the New York Herald Tribune and Sports Illustrated.  He brought sports to the masses through Newsweek and also wrote some highly-regarded books.  Last year he was inducted into the US Basketball Writers Hall of Fame.  He died, far too soon, at age 47 in 1991.

In the days before computers, one of Pete’s columns reviewed a system for betting on NFL games.  It was a betting wheel, with cardboard overlays and windows.  You lined up one wheel for the point spread, another for the difference in team winning percentage, and a third for…..well, you get the idea.  Then you looked at the “result” window and it said either “Bet” or “No Bet.”  Pete’s review tried all of the games for that week and he kept getting “No Bet” as the answer.  That was probably good advice, but it was frustrating for a man of action.  He also was the handicapping expert on some of the networks.  His conclusion was that the device must have been put out by Gambler’s Anonymous!

We can now see that this was one of the first examples of multi-variate data mining, a precursor to modern predictive methods in sports and the markets.

The Modern Equivalent

What brought this to mind was the many reminders about how over-valued stocks are if you look at trailing earnings.  You can see the Shiller PE ratio in many places, but I favor this chart.

You can see that this approach will make sure that you get a chance to buy stocks every thirty years or so.  The author of the article suggests that forward earnings are “notoriously unreliable.”  True enough.  When Pete tried to pick next week’s football games he was only about 50-50.  Even a small edge made a lot of money, but you would have to call the forecasts “unreliable.”

Meanwhile, the scores of last week’s games are available in the newspaper.  Unfortunately, the betting window is closed.

For those participating in the stock market, the earnings season will be important.  For those who are convinced that stocks are overvalued because of write-downs in 2008, you can wait a long time for those earnings to roll out of the ten-year window.

Reviewing Last Week

The news last week was pretty good.

The Good

• The Fed minutes were good.  It is obvious that the various policy accommodations will be removed very slowly, with special attention to economic weakness.  The Fed is not worried about inflation.  There is a little dissent, but nothing to indicate a policy shift.
• The general economic data is beginning to show a pattern.  The ebullient Larry Kudlow sees a lot of “V’s” in the data.  Even the curmudgeonly Floyd Norris is noticing the signs of improvement.
• For a level-headed summary of what has been happening, check out the viewpoints from Liz Ann Sonders, Chief Investment Strategist for Schwab.  She carefully parses indicators from many sectors.

The Bad

• The job picture is still terrible.  The BLS JOLTS report shows no improvement in job openings relative to job applicants.
• Long-term rates are edging higher.  Despite some great bond auctions, with strong demand, the rates at the long end of the curve are moving higher.  I am putting this in the “bad” category, since higher rates compete with stocks and imply more costly financing.  At some point, extremely low rates imply deflation concerns, so a return to normal might not be so bad.
• Mortgage rates are edging higher.  The jury is still out on whether this is a part of the general move or linked to the end of the Fed’s purchase of mortgage securities.  It bears watching, given the implication of higher rates for the housing market.

The Irrelevant

Dow 11,000?  Who cares about the round number?  What is interesting is that market averages are now approaching pre-Lehman levels.  It might be worth thinking about whether things are more promising now than they were in September of 2008.  Here is an interesting list from Damien Hoffman.

Our Trading Forecast

Our own indicators remain bullish, and that was our vote in the weekly Ticker Sense Blogger Sentiment Poll. Here is what we see:

• 93% (87% last week) of our ETF’s have positive ratings.  This is very strong.
• The median strength is +41 (up from +31 last week).
• 92%  (up dramatically from 69%) of the sectors are in the “penalty box,” showing a continued high level of uncertainty and risk.
• Our Index Package now has a solid, positive rating, consistent with a gain in the market over the next three weeks.

Investment Implications

Despite the year-long market gains, most people are not really participating.  The 2008 shock may be costly for a generation of investors, as well as the boomer types who need to retire.  The Pragmatic Capitalist captures the sentiment graphically, but read the entire article.

For a scorecard on what to watch for in earnings, Matt Phillips has a great story.

And finally, Prof. Shiller is much more modest in his claims than his strident followers.  I suggest that disciples watch this interview with Henry Blodget in its entirety.  Pay special attention to the following points:

• The right PE entry varies by age, circumstances and many other factors
• He is pretty casual about entry ratios over a range of 40% or more — listen to it.
• He thinks that most people should consider a financial advisor instead of deciding this on their own.  No kidding!

I expect a skeptical reaction to earnings, just as we saw in the last two quarters.  There will be suspicion whenever the earnings, the revenue, and the outlook to not beat expectations.  This means some buying opportunity ahead.