Earnings Season Begins Well

7/30/2015


With worries about Greece and China on the back burner for now, Wall Street's attention is shifting to earnings-reporting season. For now, a slightly cautious but mostly invested posture remains appropriate. Our buy lists have 82.5% to 83.1% in stocks.

On the defensive

The market's reaction to quarterly results is always crucial, but this earnings season could prove especially telling. With the S&P 500 Index and Dow Industrials within 1.5% of all-time highs, a positive response to the results could be enough to trigger some panic buying from underinvested portfolio managers.

The Dow Transports need to rally more than 11% to surpass their December all-time closing high of 9,217.44, so a bullish reconfirmation under the Dow Theory is unlikely in the near term. But the Dow Theory will remain in the bullish camp unless the Industrials close below 17,164.95, and we'd be inclined to add modestly to our stock-market exposure if the Industrials reach new highs and the Transports bounce.

On the downside, a close below 17,164.95 in the Industrials would require a pullback of less than 5%, so a bear-market signal is also quite possible this earnings season. The Dow Transports have rebounded from lows reached in early July but remain in a downtrend, so a move to significant lows in the Industrials would be enough to confirm a switch to the bearish camp.

Sentiment surveys and mutual-fund cash levels suggest investors entered earnings season on the defensive. While the season is only getting started, the positive reaction to early results suggests expectations may have come down enough to allow for positive surprises.

Based on consensus forecasts compiled by Thomson Reuters, revenue for the S&P 500 Index is expected to be down 3.9% from the year-earlier quarter — the worst showing since 2009 and the second consecutive decline.

Per-share earnings for the index are expected to be down 2.9%. That would be the first decline since 2009, but history suggests earnings will come in higher than current forecasts. Moreover, much of the expected decline reflects unfavorable currency translation and the more than 50% decline expected for the energy sector.

Conclusion

If companies provide encouraging guidance for the second half of 2015, investors are likely to look past the June-quarter impact of unfavorable currency translation and lower oil prices — and stocks are likely to rally. For now, subscribers should maintain a mostly invested posture while looking for opportunities one stock at a time.


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