Crucial Earnings Season Nears


The Dow Industrials and Dow Transports began the third quarter with all-time highs, reconfirming the bullish primary trend. Encouragingly, the broad market participated in the breakout, with advance-decline lines for the S&P 500, S&P MidCap 400, and S&P SmallCap 600 indexes reaching new highs. A pickup in volatility is likely as earnings season gets in gear, but a nearly fully invested posture still seems appropriate. Our buy lists have 96.3% to 99.6% in stocks.

Resilient profit estimates

About every three months for more than five years, we've predicted that the coming earnings-reporting season would be crucial. That safe prediction has proved correct every time, for the market's impressive run from its March 2009 low has been fueled by an equally impressive jump in corporate profits.

Per-share earnings for the S&P 500 Index for full-year 2013 were 80% above the total for full-year 2009 — and 24% above the prior calendar-year record set in 2006, according to Thomson Reuters. Per-share profits rose 5.6% year-to-year in the first quarter of 2014, and the consensus calls for a 6.3% increase in the second quarter.

Since 2009 bears have argued that the profit gains, helped by cost cuts and financial engineering, are unsustainable. But investors have mostly applauded the quarterly reports. In fact, nearly 80% of the S&P 500 Index's advance since the second quarter of 2009 has come during earnings-reporting seasons, which run from two weeks before to four weeks after Alcoa ($15; AA) posts results.

Because the market has rallied into this earnings season, investors may be a bit harder to impress. Also, June-quarter estimates have held up relatively well, with the consensus for S&P 500 Index profits down 1.5% since the beginning of the quarter. The modest decline — the smallest since the first quarter of 2011, according to FactSet — could make it harder for companies to deliver positive surprises.

Still, the resiliency in profit estimates bodes well for full-year results; the consensus now calls for about 9% profit growth for 2014, slightly higher than was expected on April 1. For 2015, the consensus calls for 11.5% growth.

Our advice

For now, maintain a nearly fully invested posture while looking for opportunities in reasonably valued growers. Don't be afraid to buy stocks that rally on better-than-expected results, and don't hesitate to sell those that truly disappoint. For new buying, particularly timely names include Foot Locker ($52; FL), Lear ($91; LEA), and United Rentals ($107; URI).

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