David Evanson and Oliver Pursche
Forbes.com, Spring, 2012
Alcoa (AA) once again ushered in earnings season after the close yesterday. It was a fairly decent report with AA surprising to the upside delivering $0.10 a share, versus the consensus $0.05 loss.
Other bellwethers reporting this week include Google (GOOG), Wells Fargo (WFC), Cisco (CSCO) and Citigroup (C).
With the market off 4.8% from the April 2 high, there’s a decidedly negative aura cast over this earnings season. While markets are, to some degree emotional creatures, there’s some data to back up the sentiment: through March 31, 109 companies made pre-announcements. Of these, 81 warned disappointing news would follow, while only 28 indicated a positive surprise. Further, consensus earnings growth forecasts for the first quarter, as compiled by Factset, are actually a negative, albeit just slightly at -0.1%.
So, what’s an investor to do?
I’m counseling them to rebalance their portfolio as needed, take some unrealized profits, but to by and large stay the course because the best is yet to come.
First, the rebalance and profit taking: Our technical indicators are telling us the sell-off may continue a bit longer, but we do not expect a repeat of last summer. Given the light trading volume, and the absence of fresh news, I am seeing and expect to see an orderly, healthy sell off–most likely around 6% to 8%. That means we’ve got a little further to go.
Accordingly, if unrealized losses make you queasy you might take some profits and raise cash among what you consider to be weaker positions.
As for what’s to come, I expect corporate earnings to keep rising, albeit at a slower pace than in the previous two years. The global economy will continue to improve leading to a stronger earnings forecast for 2013, and improved investor sentiment.
As such, I expect the high quality, high dividend paying stocks to continue to serve investors well, but also expect growth-oriented stocks to gain investor attention through (price earnings ratio) multiple expansion.
Even though stocks have risen sharply in price since March 2009, valuations are still very attractive. This is principally due to the fact that corporate earnings have grown at a quicker pace than share prices have appreciated. Hence, earnings multiples have actually declined over the past two years, and remain at low levels.
In addition to rapidly rising earnings, multiple expansion has been hampered by concerns over the European debt crisis spreading, potential disruptions of the oil supply due to Middle Eastern unrest (Syria, Iraq, Iran), and fears of a “hard landing” for the Chinese economy.
However, our indicators convincingly suggest to me an abjectly negative scenario is unlikely to fully materialize (though I suspect one of the above-mentioned events is likely to unfold, but view it as highly improbable that all three will occur), and this sets the stage for long overdue multiple expansion. As this unfolds in the coming quarters, I expect companies with rapid earnings and revenue growth, i.e. growth stocks, to take leadership and outperform the broader markets.