Earnings Trigger Rebound

11/3/2014


Helped by a solid start to third-quarter earnings season, stocks of nearly all stripes have bounced from the lows reached in mid-October. Many of the cyclical groups that suffered most in the downturn have led the rebound, and the Dow Transports have surpassed their September high.

With a close in the Dow Industrials above their September all-time high of 17,279.74, the bullish primary trend would be reconfirmed under the Dow Theory. If the Industrials fail to reach new highs, a breakdown below the October lows of 16,117.24 in the Industrials and 7,717.69 in the Transports would represent a bear-market signal.

For now, we're watching the averages and looking for opportunities one stock at a time. Our buy lists have 90% to 92% in stocks, reflecting this week's addition of Micron Technology ($32; MU).

Profit progress

Stocks began to rebound as earnings-reporting season got underway, with several bellwethers in the technology and industrial sectors reporting better-than-feared results. So far, a higher-than-normal 71% of S&P 500 companies have reported earnings above consensus expectations, according to Thomson Reuters.

Earnings for the S&P 500 Index are now projected to rise 8.1% from the year-earlier quarter, which would represent the best third-quarter growth in three years. Eight of the 10 sectors in the S&P 500 are expected to show year-to-year profit growth, with four on track for at least 11% growth. Revenues for the S&P 500 Index are expected to be up 3.8%, says Thomson Reuters.

Earnings guidance for the fourth quarter has been roughly in line with long-term norms, with more than 70% of the companies providing guidance falling short of consensus numbers. Consensus estimates now project 8.4% year-to-year profit growth for the S&P 500 Index in the fourth quarter, down from the 11.1% expected on Oct. 1, says Thomson Reuters.

For full-year 2015, the consensus calls for 11.0% growth, down from the 12.4% expected on Oct. 1. But most of the decline has been concentrated in the energy sector, which has been hurt by falling oil prices.

Conclusion

Consensus expectations for 2015 likely need to come down more. But continued 5% to 10% profit growth for the S&P 500 Index should be enough to sustain the bull market, partly because the Federal Reserve is seemingly in no hurry to raise short-term interest rates. Still, a failure to reach new highs in the Dow Industrials would signal some uncertainty regarding the business outlook, so near-term trading deserves close attention.


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