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US 2Q earnings continue to come in stronger than analysts had predicted. With almost two thirds of the S&P500 having reported, 75% of companies are beating earnings estimates, and only 16% are missing. On average, 2Q EPS is so far coming in 17% above expectation, a meaningful beat. The bottom up estimate for 2Q EPS, filled in with recent announcements, has moved from $13.85 to $15.26. Full year 2009 bottom up earnings forecasts are now just under $60, making the almost 1,000 level of the index an acceptable 16.5 multiple.

On the downside, US earnings surprises are still coming mostly from cost control, with overall top-line revenues coming in close to market expectations. We elect to interpret this positively, as an indication that cost cutting is nearly its end, positioning future earnings growth with a good starting point. We continue to expect that S&P500 EPS will next year return to near its long-term trend.

We remain overweight small caps in the US, which so far have merely kept pace with large caps. Small cap indices contain many regional banks, and have been the favorite shorts for bears. We do see financials generally outperforming and thus add this to the higher beta and more cyclical nature of the Russell 2000 to stay overweight.