The expectation ratio continues to forecast a stronger than expected rebound in corporate profits. The ratio, which compares sentiment readings with real earnings, signaled the sharp downturn in 2008, the turnaround in corporate profits in early 2009 and continues to forecast strong growth in profits compared to sentiment. The recent downturn in the ratio shows that the discrepancy between sentiment and corporate profits likely peaked last quarter when an astounding 75% of companies topped estimates. Despite this, the ratio remains firmly in positive territory.
2010 earnings will be characterized by an important transition from a margin story to a revenue story. We will be looking for the first signs of a rebound in top line growth this quarter. Although the economy remains extremely weak and we believe the secular bear market is still alive, we should begin to see single digit year over year growth in revenues in 2010. Profit margins have surged back to near record highs and should lay the foundation for firms to begin spending cash on hiring and expansions. As of now, estimates remain low enough that substantial revenue growth will continue to be overlooked, but as we enter the latter half of 2010 we will need to see substantial revenue growth to justify the surge in equity prices and to meet the expectations of the robust estimates.
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.