Earnings arrive amid gloom

7/14/2008


Stocks enter earnings season under considerable pressure, with heightened concerns regarding the global economy weighing on recent leaders in energy and materials. With quality stocks available at attractive valuations — and the last confirmed Dow Theory signal the April move to significant highs in the Dow Industrials and Dow Transports — our recommended cash position remains at 15% to 20%.

Earnings season
While earnings are always important, the June-quarter reporting season is shaping up as especially crucial. Consensus estimates project that total earnings for the S&P 500 Index will be down more than 12% from year-earlier levels, and some analysts expect downbeat results to trigger the market’s next leg lower. For at least four reasons, however, we’re comfortable heading into earnings season with 80% to 85% of equity portfolios in stocks.

Even if results are in line with expectations, the results could lend support to the bullish case for stocks. According to Thomson Financial, consensus estimates project that June-quarter earnings for the S&P 500 will be up about 9% excluding financials. Excluding energy and financials, earnings are expected to be up about 4%. Earnings are expected to be up in seven of the S&P 500’s 10 sectors.

Estimate-revision trends are decent. Comparing the most recent profit estimates to all estimates, Thomson Financial found that expectations outside the consumer-discretionary and financial sectors are holding up well. Among all U.S. companies, the ratio of positive profit warnings to negative profit warnings is slightly better than recent quarters and long-term norms.

Heading into earnings season, stocks appear oversold and due for a bounce. At 23%, the percentage of NYSE stocks trading above 200-day moving averages is near the low reached this spring. While this percentage could drop further, over the past 35 years it has seldom stayed below 20% for long.

Sentiment appears very pessimistic, suggesting even mildly encouraging earnings news could go a long way. The level of short interest is near record levels, and surveys of individual and institutional investors reveal a high level of bearishness. Among investment newsletters monitored by Investors Intelligence, the percentage of bulls has dropped to a 14-year low of 27.4%. The percentage of bears is 47%, a 10-year high.

Conclusion
The market’s reaction to profit reports should be watched closely. Accenture ($41; NYSE: ACN) represents a top pick for new buying.


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