Earnings Enliven Market Debate
Stocks have rebounded on some encouraging U.S. economic news, lifting small-company indexes to new highs and bringing the Dow Industrials and Dow Transports within 3% of their May highs. Moves above those all-time highs — 15,409.39 in the Industrials and 6,549.16 in the Transports — would reconfirm the bullish primary trend.
Bears argue that the recent strength reflects a lack of alternatives and misguided hope, that stocks are ignoring a fairly bleak fundamental backdrop. For example, at 6.5-to-1, the ratio of negative-to-positive earnings preannouncements among S&P 500 companies for the second quarter is the worst in more than a decade. Only two of the 10 sectors in the S&P 500 have seen expectations for second-quarter profits increase since April 1, and the consensus now projects less than 3% year-to-year growth for the index, according to Thomson Reuters.
Even worse, bears say, is that consensus estimates still project year-to-year growth of 8.4% for the third quarter, 12.8% for the fourth quarter, and 11.5% for full-year 2014. With few economists expecting a return to robust U.S. growth — and expectations for Europe, China, and emerging markets eroding — many believe estimates are still far too high.
Bulls argue that investors are focusing too much on earnings for the capitalization-weighted S&P 500 Index, which are being weighed down by globally exposed giants in the energy, industrials, materials, and technology sectors. The median S&P 500 company reported 4.6% year-to-year sales growth in its most recent quarter, meaning one-half of S&P 500 members delivered at least 4.6% growth. That is only slightly below the 23-year norm of 5.3%. The median change in per-share profits was 6.9%, versus the norm of 9.2%.
Moreover, the median stock appears to be discounting better times ahead, as advance-decline lines for the S&P 500, S&P Midcap 400, and S&P SmallCap 600 indexes reached new highs this month. Yet stocks remain cheap relative to bond yields. With bond yields rising and bond-fund investors suffering losses, bulls argue, money will continue to rotate from bonds into stocks.
The market's reaction will be the best gauge of whether second-quarter results are meeting expectations. A rally that lifts the Industrials and Transports above the May highs would be bullish. A failure to reach new highs in one or both averages would be discouraging, especially if followed by a breakdown below the respective June 24 closing lows of 14,659.56 and 5,990.79. For now, we remain nearly fully invested.