So Far, Earnings Season A Drag

2/2/2015


Stocks have slumped on a disappointing start to December-quarter earnings season, with companies blaming the underwhelming results on currency headwinds and sluggish overseas demand. We are maintaining a mostly invested posture, but we'd view a breakdown below the market's January lows as discouraging. For now, our buy lists have 87% to 94% in stocks.

Earnings headwinds

While most of the December-quarter profits reported so far exceeded consensus expectations, this earnings season has been a disappointment. Profit estimates, already down sharply heading into the reports, have continued to slump amid some high-profile shortfalls.

For the S&P 500 Index, per-share profits for the fourth quarter are now expected to be up just 3.3% from the year-earlier period on a 0.5% sales gain, according to Thomson Reuters. Even worse, expectations for coming quarters have been sharply reduced, reflecting a flurry of profit warnings from blue-chip companies. The June-quarter consensus calls for just 1.1% profit growth for the S&P 500 Index, down from the 5.3% expected on Jan. 1.

What we're watching

We'll be watching quarterly results closely, and we will not hesitate to downgrade any stock that no longer ranks among our favorites because of a poor profit outlook. Selling on an earnings-related decline can be painful. But the alternative — allowing your portfolio to fill up with second-tier names — can be truly hazardous to long-term returns.

We'll also be watching the broad market closely, as its path so far this year has been discouraging. After closing at new highs on Dec. 29, advance-decline lines for stocks in the large-cap S&P 500, S&P MidCap 400, and S&P SmallCap 600 indexes have slumped, with only meager rebounds from the lows reached Jan. 15.

For followers of the Dow Theory, the outlook is a bit cloudy. On the upside, a rebound above the December all-time highs of 18,053.71 in the Dow Industrials and 9,217.44 in the Dow Transports would represent a clear reconfirmation of the bullish primary trend.

On the downside, the question is whether the respective Jan. 15 closes of 17,320.71 and 8,655.94 represent significant lows. From those lows, both averages rebounded over the next four trading days, with the Industrials gaining 2.8% and the Transports 5.6%.

As a rule of thumb, the Dow Theory does not view rallies or declines of less than 3% as significant. Still, if the Transports join the Industrials in closing below the Jan. 15 lows, we are likely to raise some cash.


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