“Expectations Ahead of Reports”

The Dow Jones index has given up about 1.7% so far this week, while the S&P 500 has declined a little over 1%.  The technology concentrated NASDAQ is down 2%.  The declines are most likely the result of investors’ disappointment with the earnings reports that have been pouring from Wall Street this week. 

It’s not that the reports themselves were that bad.  They simply failed to beat analysts’ expectations sufficiently to buoy overly optimistic expectations that have crept into the market.  For example, Citigroup announced that their third quarter earnings came in at $.90, 21% ahead of last year and 6% ahead of analysts’ estimates that had risen steadily during the preceding quarter.  The stock declined 1.7%.

Amazon, the world’s largest online retailer, posted its third profitable quarter, 12% ahead of analysts’ estimates, but watched its stock drop 9% (the biggest drop in 15 months) after warning investors that growth may slow next year.  Amazon has more than tripled this year.  Amgen, the large biotech firm, beat projections by 4% and watched the stock fall by the same amount.  AT&T beat by 9% but saw a stock decline of 3%.  The list goes on and on.

On the other hand, some surprises were large enough to attract the attention of new buyers.  Hasbro, the toy manufacturer, reported a 15% earnings surprise and saw its stock rise by 6%.  Microchip companies like Texas Instruments had a great third quarter.  The Texas-based chip maker reported earnings almost twice better than expected and saw its stock rise just under 10% on the news.  That’s good news for the economy because chip sales are a very good forward indicator of the economy.

According to Zacks, of the 253 companies reporting so far, 141 have beaten analysts’ estimates, 43 have equaled them, and 69 have come up short.  Almost 75% of companies have equaled or beaten earnings expectations so far this reporting season.

Industries doing the best include basic materials like forest products and aluminum, consumer cyclicals like apparel and furnishings, diversified financial companies, software and internet services, and healthcare providers.  Of the 438 companies tracked by Zacks, net income for the third quarter is up an average of 40%.

It has been a light week for government data.  The tone was set on Monday with a lackluster report of leading indicators from theNew Yorkbased Conference Board.  The index fell .2% for the first time in six months.  The decrease mainly reflects the decrease in money supply.  However the Federal Reserve’s continued accommodative stance leads us to believe they will continue to provide ample liquidity for this economy.

The news on jobs continued to show improvement, but only gradual.  The number of Americans collecting unemployment fell to the lowest level since April and matched an eight month low, suggesting some are finding work.

On balance, there is sufficient evidence from earnings reports to support the belief that the recovery remains on track.  But caution is everywhere, particularly in the forward looking statements by managers regarding their next year’s earnings.  As investors adjust their expectations to more reasonable levels, we will likely see continued market choppiness for a while.  But looking longer term (three to six months hence), plenty of companies and industries remain undervalued relative to their earnings potential.  Gains should continue.