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The message from this earning's season is that 1) the bottom of the recession is now behind us, 2) Visibility going forward remains poor, 3) cost-cutting and restructuring have turned American companies into lean, profit-making machines, and 4) despite prospects for continued economic weakness, an economic recovery seems closer than ever. Earnings season was NOT the debacle I had originally pictured. The S&P 500 reached its most recent bottom around the beginning of earnings season on July 8, and is up a healthy 13% since then. On July 9, I claimed the S&P 500 was ready to bounce, but I expected a weak bounce that would soon give way to earnings-related selling. I also expected the June highs to hold. Reviewing the performance of the companies that seemed to send up the proverbial red flag provides a great demonstration of how the market's obstinate faith in the near-term future has presided handily over any and all negative indicators.
On July 7, Acuity Brands (AYI) warned about the drag from non-residential construction, and MSC Industrial Direct Company (MSM) warned about the dim view held by its customers for near-term improvement in the economy (click here for more details). If you had bought the stocks of these companies at the close of trading AFTER these earnings reports (five weeks ago), you would now be up 17% in AYI and 13% in MSM. Not bad for delivering bad news.
After these seemingly gloomy reports, I was unfazed by the market's enthusiastic response to the earnings reports of Intel (INTC) and Goldman Sachs (GS) a week and a half later. Instead, I chose to focus on the cautious and sometimes downright dour commentary pouring out from many other conference calls. Here are the price performances of the stocks in each company that seemed to deliver bad news about the economy's near-term prospects. I measured performance from the close of trading after each earnings report or warning:
- Martin Marietta Materials, Inc. (MLM): 15%
- W.W. Grainger, Inc. (GWW): 7%
- Fastenal Company (FAST): 19%
- CSX Corporation (CSX): 20%
A clear sign of the market's determination came following Caterpillar's (CAT's) earnings report on July 21. I was unimpressed by revenue guidance of $32-36B vs. the analyst consensus of $34.86B given CAT missed revenue expectations for the previous quarter by almost a billion dollars. The FY09 earnings guidance far exceeded analyst consensus of $1.02 per share but had an extremely wide range of $1.15-$2.25 per share. CAT talked about very weak end-user demand continuing into its third quarter, but it expects the fourth quarter to bring a significant rebound. I am assuming CAT expects its fourth quarter to deliver a perfect combination of increased earnings leverage and strong revenue (pricing) performance. CAT's stock had already bounced 20% in the six trading days preceding earnings, but it still responded to the earnings news with a gap up of another 11%. The stock faded hard into the close, but it is now up yet another 17% since then. Clearly, I was on the completely wrong side of sentiment on that one (after riding the post-earnings fade, I have taken my medicine and executed short-term longs in CAT).
All this post-earnings enthusiasm helped to propel the S&P 500's double-digit performance in a month (it also helped that as the S&P 500 hit 940, Goldman upped its year-end target for the index from 940 to 1060). It is the kind of buying that declares an unwavering confidence in near-term economic prospects and an expectation that earnings (and revenue) estimates going forward are too low. I am biased by my overall bearishness to expect that rising bullish sentiment is setting the market up for a significant correction going into the Q4 earnings cycle. (I will not bother mentioning the over-bought technical indicators because they have not mattered much for months now!) The most significant wildcard relevant to my expectation is the impact - perceived, expected, or real - of accelerating stimulus spending (click here to read an interesting summary of Doug Kass's reasons for being bearish).
Be careful out there!
Full disclosure: long CAT, short SSO. For other disclaimers click here.