Stocks Rally Into Earnings Season


Stocks have rallied on expectations of more money-printing from the Federal Reserve and more earnings growth from corporate America, putting the averages within striking distance of this year’s highs. Closes above 11,205.03 in the Dow Industrials and 4,806.01 in the Dow Transports would put both averages at two-year highs — and the Dow Theory in the bullish camp.

For now, we intend to hold 20% to 30% of equity portfolios in a short-term bond fund while watching the averages and looking for buying and selling opportunities one stock at a time. With closes above 11,205.03 and 4,806.01, our recommended cash range will drop to 10% to 20% and our hotline will be updated with specific instructions.

Will investors sell on the news?

The Federal Reserve is now widely expected to resume large-scale bond purchases, but the size and shape of this “quantitative easing” program will be in doubt until the Fed’s Nov. 3 meeting. Whether or not it makes sense to debase the U.S. currency by purchasing bonds with dollars created out of thin air, investors are banking on a significant announcement from the Fed.

As yields on Treasury bonds have dropped, the dollar has slumped and commodity prices have surged — all symptoms of the near unanimity of opinion on Wall Street regarding the Fed’s intentions. If the size or scope of the Fed’s Nov. 3 announcement underwhelms investors, stocks could be vulnerable to profit-taking.

Similarly, while year-to-year earnings growth for the S&P 500 Index in the September quarter is likely to exceed the 24% consensus forecast, investors have grown accustomed to positive surprises. More than 70% of S&P 500 companies have exceeded consensus profit estimates for four straight quarters, the longest streak since Bloomberg’s data begins in 1993.

As always, it will be the stock market’s reaction that reveals whether results and guidance have met expectations. Consensus estimates project S&P 500 Index earnings will climb 14% next year to a record $95 per share, and the index remains reasonably valued at 12 times that estimate. So, if 2011 estimates can hold up through earnings season, the stock market’s year-ahead prospects would benefit.


With a close above 11,205.03 in the Industrials and 4,806.01 in the Transports, our recommended position will be cut to a range of 10% to 20% — and our hotline will be updated with specific instructions. For new buying, especially attractive names include Aflac ($55; AFL), IBM ($140; IBM), and Rogers Communications ($40; RCI).

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