Getting your share of corporate earnings, via price appreciation or dividends, is the main reason to invest in stocks. The two-year rally has been powered by increasing earnings prospects and low interest rates. If you want to understand earnings, you need to look ahead. My recommendatoin?
Watch the one-year forward earnings forecasts.
This was the topic for what I felt was my most important article last year. I don’t think I can improve on my earnings preview six months ago:
As we embark on a new earnings season, a consideration of how we think about earnings may be especially helpful.
As background, here are two elements of Wall Street Truthiness about earnings:
- Companies and analysts are wildly optimistic about forward earnings.
- Companies lowball earnings expectations so that they can deliver an earnings “beat.”
The astute readers of “A Dash” will immediately see that these widely-held beliefs seem to be inconsistent. Many of those in the financial punditry happily advance both arguments — but not in the same post.
There is an obvious explanation. At some point there is a “crossover,” a point where the forward estimate is accurate. If both statements are true, we know that estimates are accurate at some point, so when does the crossover occur?
I went on to produce data showing the accuracy of analyst estimates on a one-year forward basis.
Many people remain focused on the (lack of) earnings from 2008. This approach will keep you out of stocks until 2018 or so, when the bad year rolls out of the ten-year backward-looking method.
I’ll return to the earnings preview in my conclusion, but let us start with the regular review of the week’s data.
Joining Twitter: A Small Note
After observing the usefulness of Twitter for many participants at the Kauffman conference, I have decided to give it a try. Don’t expect news about what I did on my birthday today (a day shared with fellow bridge player Omar Sharif and Harry Morgan). My current thought is to mention ideas, possibly half-baked, reactions to some events, interesting articles, and other items that I might never write a full piece about. I have no idea how this will work out, and I invite feedback. @dashofinisght is the Twitter name.
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.
In most of my articles I build a careful case for each point. My purpose here is different. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but some will disagree. That is what makes a market!
Last Week’s Data
The most important news was positive.
Most major economic indicators show that the US economy has returned to its normal state, self-sustaining growth. Many seem to have forgotten that economic growth is normal, including the use of slack resources to expand and to build new businesses.
- Economic growth forecasts improved. The ECRI Weekly Leading Index improved slightly, to 131.2. The growth index also moved higher to 6.7%. These continue to be good readings, but everyone is watching the indicator closely.
- Risk as measured by the St. Louis Fed Stress Index, remains very low. This measure tracks a lot of market data in the eighteen inputs. It is not a poll, nor opinions, nor a collection of anecdotes. We should all pay attention to some real data. The value moved to -.027, a bit lower than last week’s +.021. These are completely normal readings for a scale measured in standard deviations from the norm. For more interpretation, the St. Louis Fed published a short paper with a very nice chart that helps to interpret this index. The chart does not reflect the recent continued decline in stress, but it identifies the dates for important recent events. The paper also has a longer version of the chart, illustrating past stress periods. I am not going to run the chart each week, but I strongly recommend that readers look at the paper. In the 2008 decline there was plenty of warning from this index — no sign right now. The scale is in standard deviations, so anything short of 1.0 or so is neutral territory. I am doing more extensive research on this indicator.
- Jobless Claims moved lower. I am leaving this in the “good” category because of the small improvement, but I think The Bonddad Blog interpretation is correct: “The BLS reported that Initial jobless claims last week were 382,000. The 4 week average is 389,500. This is the seventh week in a row that this number has been initially reported below 400,000. On the other hand, this series has not made a new low in five weeks.”
- Businesses plan more hiring. Floyd Norris discusses the Business Roundtable data.
- The government shutdown was avoided. I have been predicting this with some confidence. I know it seemed like a close call from the media accounts, but issues that can be compromised with dollar changes are usually resolved. Obviously, we will all return to the underlying issues from this debate. For now, a market negative was avoided.
NB: The ECRI and SLFSI are actually readings from week-old data.
The biggest negative was the continuing spike in energy prices.
- Energy prices move higher. This continues as the biggest threat to the economy.
- Housing, by any measure, remains very poor. A flat housing market would end the drag of more than 1% on GDP. A real turnaround would be better. Last week’s mortgage data continued the negative story.
The ugliest news this week was the story about the world of foreign exchange trading. Would it surprise you to learn that most of the little guys use excessive leverage and lose all of their money? That the firms that facilitate their trades have a real mission — to replace customers they know will blow out.
I usually learn about these stories after it is too late. Investors who lost money in stocks in 2000, then stampeded into real estate and lost there, are now looking for short cuts to riches.
Abnormal Returns had a great screencast on this topic on Monday.
Everyone should read these stories and help their clients, family, and friends avoid losses.
Our Own Forecast
We base our “official” weekly posture on ratings from our TCA-ETF “Felix” model. After a mostly bullish posture for several months, Felix has turned much more cautious. We shifted from our neutral posture to bullish in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close. This is based on improved ratings in the various index ETFs, as well as the general trend. Here is what we see:
- 89% of our 56 ETF’s have a positive rating, up from 55% last week. This is very encouraging.
- 93% of our 56 sectors are in our “penalty box,” the same as 93% last week. This is an indication of very high short-term risk.
- Our universe has a median strength of +35, up nicely from +21 last week.
The overall picture improved last week. We maintained positions in trading accounts at 40%, holding only the two strongest sectors. We will add positions on Monday and Tuesday.
[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 ETF email list. You can also write personally to me with questions or comments, and I'll do my best to answer.]
The Week Ahead
On the economic front we will see retail sales data, with everyone poised to see if higher gasoline prices have hit spending on other products. We get both PPI and CPI data. The expected difference between headline and core numbers will fuel the discussion about the Fed and profit margins. Michigan sentiment data may also show the gasoline price effect.
The earnings story is important, but I expect a skeptical reception. Any company without strong guidance may see a weaker stock price. Any company that talks about negative effects from energy costs will see a lot of publicity and plenty of selling.
Earnings growth continues to be strong, but the data have attracted little respect. Most of the punditry is looking for a reduction in profit margins, which have continued at a record level. There is an interesting report from Goldman Sachs (via Charles Kirk’s excellent links) that explains why index margins continue to increase, even as some company margins fall. As is usually the case when an argument requires some study, those who disagree will merely scoff without reading it.
I expect mean-reverting behavior in profit margins at some point, but I think the forecasts of lower earnings are wrong. Employment and revenues are also reverting to the mean — and that is much higher than current levels.
For the moment, I am adding to long-term positions, but only cautiously.
Originally published at A Dash of Insight and reproduced here with permission.
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