Friday, October 09, 2009

The 3rd Quarter Earnings Derby Is About to Begin

Next week 3rd quarter corporate earnings reports will begin in earnest. We project that this quarter's earnings will, again, beat expectations by a wider margin than is now anticipated by most investors. We said the same thing just prior to second quarter releases and the earnings results even outdid our best guesses as 75% of S&P 500 companies beat their Wall Street estimates. We know all the arguments that last quarter companies beat earnings on "cost saves" and not on truly better business. Indeed, S&P 500 earnings were nearly 25% lower than 2nd quarter 2008 earnings. Our view, however, is that the cost saves were so sharp and accomplished so swiftly that corporate America is to be commended for their flexibility and dexterity in right-sizing their cost structures. This means that as the economy begins to turn higher, which we believe will happen this quarter, that earnings will be highly leveraged to the economic uptick. Third quarter earnings are also projected to be lower than a year ago. But that is not what will drive stock prices. That will be determined again by how 3rd quarter earnings compare to the Street estimates. In this regard, we believe investors will like what they see. Our best guess is that 65%-70% of companies will beat their estimates. This will be a lower "beat rate" than the second quarter, but higher than the five-year average. We expect earnings in the techs, consumer cyclicals, materials, and industrials will lead the "beat" parade on a percentage basis. While we are optimistic that earnings will be better than expected, we do not predict that the markets will rally another 1000 points on the DJIA as they did in the two weeks from July 15 to August 1. We would be very surprised, however, if the stock market were not able to push through DJIA 10,000 by the end of the earnings season. In short, we believe the run up in stock prices is anticipating an uptick in the economy, which will, ultimately lead to higher year over year earnings. When that finally happens, many of the holdout bears will be forced to capitulate and begin buying. We would guess that that is when the stock market will go into a long pause and bore the new bulls half to death. We'll keep you posted for a few weeks on how the Earnings Derby is unfolding.