Earnings Arrive Amid Optimism
The major averages head into earnings-reporting season near recent highs, with encouraging economic news countering interest-rate worries. While volatility would not be surprising amid March-quarter earnings news, a mostly invested posture seems appropriate considering the availability of reasonably valued stocks and the recent significant highs in the Dow Industrials and Dow Transports.
To accommodate this week’s addition of Lubrizol ($94; LZ) to our Buy List, our recommended cash position has been changed to a range of 5% to 15%. Of the portion of your portfolio committed to equities for the long haul, we suggest holding 5% to 15% in a short-term bond fund like Vanguard Short-Term Investment-Grade ($10.68; VFSTX).
Recent U.S. economic reports have shown strength in industrial demand, home prices, consumer spending, and hiring. Growth overseas also appears to be improving, led by a resurgent industrial sector. Meanwhile, U.S. labor productivity is at record levels, and wage growth remains modest.
The overall picture is a bullish one for corporate profits, with consensus estimates projecting 37% year-to-year earnings growth for the S&P 500 Index in the March quarter. Guidance from companies has been far more favorable than is typical, and consensus 2010 profit estimates for economically sensitive sectors have seen meaningful increases over the past month.
For investors, the question is how much of the bullish picture is already reflected in stock prices. The S&P 500 Index has gained 12% since Feb. 8, with advances in five consecutive weeks. Measures of share-price momentum suggest stocks may be extended on a near-term basis, and surveys of investor sentiment reveal a relatively high level of bullishness.
Against such a backdrop, traders may be tempted to lock up profits if March-quarter results don’t meet the high end of expectations. Earnings are very likely to exceed consensus estimates, but investors may be anticipating blowout profit surprises and improved guidance for full-year 2010.
Notably, the S&P 500 began pullbacks of least 5% in the September- and December-quarter reporting seasons, even though profits exceeded consensus estimates for both quarters.
As always, the market’s reaction to earnings will reveal whether results have met expectations. Near-term volatility would not be surprising, but we are inclined to view any pullback as a correction in a bull market. For new buying, top picks include Aflac ($56; AFL) and Raytheon ($57; RTN).