Earnings season is long over and investors are already beginning to look at Q2 earnings for the next market catalyst. Analysts currently expect Q2 earnings to fall 36%. Analysts have raised their 2009 earnings expectations for the first time this year to $57. A very important trend is occurring in corporate earnings. As the economy and earnings appear to be seeing some signs of stabilizing the estimates are remaining low. I’ve attached my proprietary expectation ratio below. This ratio calculates how real earnings expectations compare to analysts expectations. It is a leading indicator, turned negative in 2007 and turned positive for the first time in Q4 of 2008. In essence, it calculates whether companies are likely to beat earnings in the future. Along with it is the sharp decreases in analysts estimates. As you can see, the ER has risen as expectations have fallen. This means that analysts are cutting their estimates too far too fast and companies are outperforming. As we saw last quarter, this bodes well for corporate earnings. Although last quarter was a disaster by any standard, the figures were “better than expected” and triggered the current market rally. I think we could be in for another quarter of the same treatment.
My preliminary glance at Q2 estimates and overall earnings leads me to believe that it will be a very bad idea to be short heading into this next earnings season unless estimates jump in the next 6 weeks. Alcoa doesn’t report until July 7th and earnings will pick-up momentum in the two weeks after. I still believe the market could run into some resistance between now and then, but as of now the earnings trends bode well for stocks. Of course, this isn’t necessarily a positive long-term trend as earnings will still be down sharply – it’s more a reflection of the short-term ignorance of the analyst community. Plus, most of the earnings outperformance is due to cost cutting as opposed to real organic growth. I’ll update this weekly as we get closer to the real thing.
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Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.