Weekly Commentary October 25th, 2010

Consistent downgrades from Wall Street analysts have set us up for a very smooth start to the earnings season.

"Of the 132 companies in the S&P 500 that reported results since Oct. 7, more than 85 percent have topped analysts’ per- share earnings estimates, according to data compiled by Bloomberg. Analysts surveyed by Bloomberg predict 26 percent growth in third-quarter profit from a year earlier for S&P 500 companies, the fourth straight quarterly increase." (Bloomberg)

The chart I have displayed below from the Bespoke Investment Group, LLC. (B.I.G) shows earnings per share beat rate (the % of companies that beat estimates) has crushed the long-term historical average of 63%.

historical earnings beat

A bit more concerning is the top line growth of companies. After all, it's one thing to make a profit from cutting expenses (jobs, technology, health care etc.) and an entirely different picture to have revenue growth due to increased demand by the consumer.

If you look again at the B.I.G. data, revenues have gotten off to a relatively weak start. Only 58% of companies that have reported beat top line estimates so far.

broken pictureAn obvious absence of top line growth from the broad based market does not mean we can't get a lift in GDP growth. After all, it's hard to fall off the floor. Analysts are anticipating Q3 GDP growth to come in around 2% vs. the 1.7% for Q2. Much of this marginal increase will be driven by an increase in consumer spending. It looks like consumer spending was up 2% for the 3rd quarter.

If you scroll back through some of my earlier posts you'll see a common formula:

Jobs, Wages, Profits = Consumption and Investments = Jobs, Wages, Profits

Here's the good news, companies are making profits albeit at the expense of jobs, but profits none the less. These profits should be circulated back into our economy through planned investments, dividends and perhaps a few jobs here and there.

The story goes that if enough profits are created, enough jobs might follow and then reckless consumption can start all over again (Happy days will be here again). This is what I believe is being discounted in our current equities markets. Of course, I did leave a few key factors out of the equation: Savings and Consumer Credit. While savings is on the rise, consumer revolving credit is still being shrunk. Both of these have a draw down impact on consumption. Let's see how these play out in the coming months reports. I'll keep you posted.

For now, it's an investing environment with lowered expectations, muted consumption and better profits.

My themes continue to be:

  • Weak dollar opportunities-exporters
  • Select technology-specifically in business processing
  • Media (Print that is adapting to online) see some tweets on this @PHCOadvisors.
  • Rare Earths (again see our Tweets on this)

I'm also anticipating some kind of equipment tax credits that could be passed during a lame duck session. There seems to be some common ground on this element of tax cuts so equipment manufacturers could benefit. More on this in coming tweets and postings.