Friday, July 20, 2012

The Morning Call--Can earnings continue their surprising performance?

The Market


The indices (DJIA 12943, S&P 1376) had another good day, remaining within their (1) short term trading ranges [12022-13302, 1266-1422] and (2) intermediate term uptrends [12001-17001, 1262-1842]. Both of the Averages closed above the interim resistance levels (12903, 1364) for the second day. A close above those levels today will take out the interim resistance as well as the upper boundary of the S&P pennant formation, setting the stage for a move to 13302, 1422.

Volume rose, breadth declined. The VIX fell, finishing the day very close to the lower boundary of its intermediate term trading range (which is also the neckline of the developing head and shoulders formation). Again, a close below that level would be a positive for stocks.

GLD rose, remaining above the lower boundary of its intermediate term trading range.

Bottom line: the primary trends continue to be firmly in place though the Averages are moving into the upper zones of their trading ranges with a firm bid under the Market. As such, it is time to be carefully watching those stocks near their Sell Half Ranges (for a fundamental sale) or major resistance levels (for a trading sale).



Lots of economic data yesterday with virtually all of it negative: weekly jobless claims were well above expectations though it was largely the result of a big seasonal factor; existing home sales were terrible although inventories painted a more positive picture; the Philly Fed index was negative but less negative than last month; and finally, the June leading economic indicators fell more than estimates.

This negative albeit confusing data flow seemed to have little impact on investor sentiment; neither did the escalating violence in the Middle East. What apparently has investors getting jiggy is a better than expected (downwardly revised) earnings season (to date 74% of the reporting companies have beat earnings estimates though only 57% have beat revenue forecasts)---and that makes sense, especially if it occurs as revenues are rising and/or margins are improving. The problem is that (1) much of the globe is experiencing slippages in economic growth [see revenue ‘beat’ above], (2) commodity prices are starting to rise again and (3) margins are at historical highs.

I know that there is a whole cadre of gurus out there that have been anticipating corporate profit growth problems and to date they have been on the wrong side of the trade. But as incredible as the performance of US corporate management has been through the turmoil of the last four to five years, there is a point where all the expertise in the world can’t cut any more costs, offset any more rising raw material costs or create more sales in slowing revenue environment.

I also know and appreciate the ‘climbing a wall of worry’ thesis. Indeed, as a contrary opinionist, more often than not, I am firming in that camp. But (1) the ‘wall of worry’ generally consists of circumstances in which the risk of being wrong can be at least approximately quantified and (2) stocks usually are below Fair Value.

Unfortunately, at the moment, we have no idea of (1) how weak or strong the balance sheet of US financial institutions are because we keep learning everyday that they are being run by liars and thieves, (2) whether the next shot fired in the Middle East will create an explosion or (3) the magnitude of the consequences of an unraveling/collapse of the EU.

Not that any of the above risks will become manifest; but with stocks trading over Fair Value [which incidentally is based on the assumption of no recession] and in the absence of any analysis of the potential economic downside to the above events, I think that ‘climbing a wall of worry’ is somebody’s wet dream.

Bottom line: the economy appears to be tracking with our forecast and stocks are reasonably close to reflecting the Values such a scenario generates. That is about as good as it going to get, in the absence of a significant upside surprise. The problem is that there are a bushel of well known negatives with unquantifiable consequences; and that limits the possibility of an upside surprise and suggests to me a bit of caution is warranted. Hence, our Portfolios cash and gold positions. It also suggests that any Buying should be done at lower levels.

The latest from Van Hoisington (medium):

Market top economics (medium):

The latest from Ray Dalio (medium)

Steve Cook received his education in investments from Harvard, where he earned an MBA, New York University, where he did post graduate work in economics and financial analysis and the CFA Institute, where he earned the Chartered Financial Analysts designation in 1973. His 40 years of investment experience includes institutional portfolio management at Scudder, Stevens and Clark and Bear Stearns. Steve's goal at Strategic Stock Investments is to help other investors build wealth and benefit from the investing lessons he learned the hard way.