When Bad Is Not So Bad

4/27/2009


While earnings reports have triggered big share-price moves in both directions, the major averages remain near 10-week highs. The near-term action of the Dow Transports and other cyclicals deserves close attention, as continued strength in economically sensitive stocks would suggest investors are willing to look past the poor results of the March quarter.

As a partial hedge, our buy lists have 32.5% to 34% in Vanguard Short-Term Investment-Grade ($9.86; VFSTX), a relatively low-risk bond fund. We intend to take advantage of opportunities on a stock-by-stock basis, but we are likely to maintain a sizable position in short-term reserves until the market provides more evidence it bottomed March 9. First we’d like to see the Dow Industrials or Dow Transports hold above the March 9 lows when the market corrects. Next, we’d like to see both rebound above the highs established in the current rally.

For now, glass appears half full
March-quarter earnings reports were expected to be awful, and early reports have done little to dispel these expectations. Several big-name financials delivered better-than-expected profits, though the results were helped by one-time items and unusually strong results in trading. Outside of the financials, results have been mostly poor but roughly in line with expectations.

At 30%, the percentage of companies posting lower-than-expected earnings for the March quarter is above historical norms but down from the December quarter. More importantly, several major companies have said the economy is approaching a bottom. While such sentiment is far from universal among company managements, investors appear to be looking on the bright side — for now.

Particularly noteworthy is the forgiveness shown several high-profile cyclicals that delivered meaningful earnings shortfalls. Boeing ($38; BA), Caterpillar ($33; CAT), DuPont ($28; DD), and Parker Hannifin ($42; PH) posted March-quarter earnings below consensus estimates and lowered expectations for full-year 2009, yet shares of all four are up since posting results. The Dow Transports, historically a good barometer for the health of the industrial sector, have surged since earnings season began despite mixed results from railroad and trucking companies.

Conclusion
As always, it is the market’s reaction that shows whether earnings are meeting expectations. Earnings season is still young, but so far stocks have shown impressive resilience. While holding a sizable cash position seems prudent, subscribers should be on the lookout for attractively valued shares of companies delivering better-than-expected results, like IBM ($104; IBM).


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