Great Expectations

4/18/2011


Every earnings-reporting season represents an important test for the stock market. But the current season seems especially crucial, for at least four reasons:

Trading near previous highs, the averages are meeting some resistance. The Dow Theory is squarely in the bullish camp, with both the Dow Industrials and Dow Transports closing at multiyear highs in the first week of April. But some follow-through from the averages would be encouraging, as would an earnings-inspired breakout above the February highs in the S&P 500 and other broad market indexes.

Expectations are relatively high, and investors have grown accustomed to impressive results. Consensus estimates project March-quarter earnings for the S&P 500 Index will be up 12% from the year-earlier quarter, while sales growth is forecast to exceed 10% for the first time since 2006. The average S&P 500 company has exceeded consensus profit estimates for eight consecutive quarters.

While consensus profit estimates have held firm recently, expectations for economic growth have deteriorated. Consensus estimates for 2011 growth in U.S. gross domestic product have dropped for two straight months, and estimates for 2012 have dipped slightly. U.S. companies have grown faster than the U.S. economy since 2009, but now expectations for the global economy have begun to slip. The International Monetary Fund recently projected global growth of 4.5% for 2011, down from 5% in 2010. Against that backdrop, investors will be paying close attention to the full-year guidance companies provide with quarterly results.

U.S. stocks are not particularly cheap. At less than 13 times expected year-ahead earnings, the capitalization-weighted S&P 500 Index is cheap relative to 15-year norms. But the index's P/E is skewed lower by its most heavily weighted big stocks, which trade at a substantial discount. The median stock in the S&P 1500 Index of large, midcap, and small stocks trades at nearly 19 times trailing earnings — slightly higher than the 15-year norm. The P/E of the median stock in the S&P 1500 stock is a more reasonable 16.5 based on expected current-year earnings, so value-based arguments for the stock market hinge importantly on the double-digit profit growth expected for 2011 and 2012.

Our advice

Profit reports could key near-term volatility in either direction. But with the Dow Theory in the bullish camp and quality stocks available at reasonable valuations, we're inclined to view a pullback as a buying opportunity. For now, our buy lists hold 8.5% to 12% in Vanguard Short-Term Investment-Grade ($10.74; VFSTX), a relatively low-risk bond fund. For new buying, MasterCard ($263; MA) is especially attractive.


Current Hotline

Stock Spotlight

Individual Stock Reports

ISRs make stock research easy!

Perhaps the most valuable two page reports available anywhere.

All the data you would normally have to plow through years of 10-K filings, earnings reports, and reams of market data to assemble — yours all in one concise report.

ISRs contain our proprietary Quadrix scores — find out how we rate all the stocks in the S&P 500.

Visit us at individualstockreports.com