For the first time since the bear market began, an earnings season has given a boost to the stock market. Although much of this is to be attributed to the “complicated” bank earnings, it is a positive development. The primary driver of the better stock response has been the sharp reduction in analyst’s estimates and the nearly complete lack of real revisions heading into the bank earnings. I can’t think of too many banks besides Morgan Stanley that actually missed their earnings estimates. Whether this is due to better results or analyst ignorance is up for debate, but as of now I am leaning towards the latter.
Thus far, 80% of the S&P 500 has reported and the bottom line figures have been substantially better than expected. Roughly 50% of the index has outperformed analysts expectations. Only 90 of the companies have reported better revenue growth year over year – a clear sign that cost cutting is the primary driver of better bottom line growth (as opposed to true revenue growth). This is important to note because revenue growth is a much better gauge of economic strength. Companies can only cut so many costs. At some point they need organic revenue growth to drive earnings.
Estimates have declined further in the last week to $58 and this sharp decline in estimates has resulted in a far better expectation ratio. My proprietary indicator has shown drastic improvement (for those looking for a primer on the ER please see here). Much of this improvement is due to the better than expected results from the banks so the data going ahead will be much more useful. Nonetheless, this is a very positive long-term sign. Remember, the ER is a LONG-TERM indicator and the improvement in the ER shows that earnings and expectations are coming much more in-line with one another. This is a very positive development as we’ve seen this from quarters results.