Earnings Worries Weigh

4/6/2015


Because this year's new highs in the Dow Industrials have not been confirmed by new highs in the Dow Transports, we view the Jan. 30 closing lows of 17,164.95 in the Industrials and 8,649.32 in the Transports as actionable bear-market points. While the Industrials are about 3% above their Jan. 30 close, the Transports are within 0.5%.

If both averages close below those points, we'd view that as confirmation that the primary trend has shifted to the bearish camp under the Dow Theory — and as a reason to reduce our exposure to equities.

While our asset allocation also depends on the opportunities in individual stocks, a bear-market signal is likely to mean a drop in our stock-market exposure to 75% or lower. For now, we intend to watch the averages as we keep about 85% of our buy lists in stocks.

Heading into earnings season, pessimism is running high regarding near-term corporate profits and U.S. economic growth. For the S&P 500 Index, consensus estimates now project a 4.6% year-to-year decline in first-quarter earnings per share, down from the 4.2% increase that was expected on Dec. 31, according to FactSet. Not since early 2009 have estimates been cut so much during a quarter.

All 10 sectors of the index have seen downward profit revisions. But much of the pain has been concentrated in the energy sector, which is projected to report a 64% year-to-year decline. Excluding the energy sector, earnings for the S&P 500 Index are projected to be up 3.4%.

A sharp jump in the dollar has also weighed on profit expectations, especially at the big multinational companies heavily weighted in the S&P 500. For our entire Quadrix universe of U.S.-traded stocks, the median company is expected to report a 6% increase in per-share profits in its next quarterly report.

To be sure, profit expectations have also been hurt by weaker-than-expected readings on the economy. The Citigroup Economic Surprise Index, a rolling measure of positive and negative surprises relative to consensus estimates, is at its lowest level in more than three years.

Conclusion

Since 2003, stocks have tended to perform well in the six months following low readings in the Economic Surprise Index. Similarly, stocks have tended to rally in earnings seasons that followed widespread downward revisions.

With both the Industrials and Transports within striking distance of bear-market points, whether that pattern repeats will be crucial. For new buying, Ameriprise Financial ($130; AMP) and Lear ($112; LEA) represent top picks.


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