So Far, Profit Trends On Track

10/25/2010


Stocks have been choppy amid a surprise interest-rate hike in China and earnings-related pullbacks in several bellwether stocks, but the Dow Industrials and Dow Transports are less than 1.5% below this year’s respective closing highs of 11,205.03 and 4,806.01. Closes above those points would put both averages at two-year highs, making it hard to see the primary trend as anything but bullish.

With closes above 11,205.03 and 4,806.01, our recommended cash position will be cut to a range of 10% to 20% and our hotline will be updated with specific instructions. For now, our three-part strategy is unchanged: watch the averages; hold 20% to 30% of equity portfolios in a short-term bond fund; and look for buying and selling opportunities one stock at a time.

Favorable earnings-estimate trends

Not surprisingly, earnings-reporting season has begun with a preponderance of positive surprises. Among S&P 500 companies, more than 80% have exceeded consensus profit estimates for the September quarter, while more than 60% have exceeded consensus revenue estimates.

For the S&P 500 Index, September-quarter consensus estimates now project year-to-year growth of 24% for per-share earnings and 7% for revenue. Eight of the 10 S&P 500 sectors are expected to deliver earnings growth for the third quarter, while nine of the 10 are expected to deliver revenue growth.

Perhaps more important, expectations for the December and March quarters have held up, with estimates for S&P 500 Index earnings edging higher for both periods since the end of September. All 10 S&P 500 sectors are expected to post year-to-year profit gains for the December quarter, while only the utility sector is expected to post a decline in the March quarter.

For full-year 2011, consensus estimates project S&P 500 Index earnings will be up 14% — a forecast many analysts view as optimistic considering the sluggish U.S. economy and the nearly 36% growth expected for full-year 2010. But the S&P 500 Index trades at less than 13 times the 2011 consensus — modest relative to historical norms and downright cheap relative to today’s interest rates.

Conclusion

If investors gain confidence that strong corporate earnings growth will continue, the Industrials and Transports should rally above 11,205.03 and 4,806.01. Closes above those levels would put the Dow Theory in the bullish camp, while a failure to surpass those points during earnings season would be discouraging. For new buying, new recommendation Ameriprise Financial ($51; AMP) represents an attractive pick.


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