April 11, 2012
Investors were bracing for an unpleasant announcement when Alcoa (AA) announced its first-quarter results after the bell yesterday, anticipating that the company would report a loss of a few cents a share. That would have marked a gloomy start to what is expected to be an underwhelming and even outright depressing earnings season, one that most analysts expect will conclude with S&P 500 companies posting results that are flat over year-earlier levels, or at best up one or two percentage points. Little wonder, then, that the S&P 500 index on Tuesday posted a loss for the fifth straight session – this time, the largest decline it has recorded in more than four months: 1.7 percent, or 23.61 points.
But Alcoa surprised everyone by reporting a profit. Analysts had forecast a loss of 3 to 4 cents a share; the company instead reported a profit of 9 cents a share, as some of the company’s businesses, such as its aerospace division, picked up the slack and helped offset the impact of higher energy costs and plunging aluminum prices. The company’s surprise profit – even though it’s nearly 70 percent below year-ago profit levels – triggered jubilation and buying on the part of investors. Alcoa’s stock jumped more than 7 percent at the start of todays trading, and stocks overall opened the session nearly 1 percent higher.
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The question remains, however: To what extent is Alcoa’s positive surprise a harbinger for first-quarter earnings? It’s important to note that the profit was generated in part because of more aggressive cost cutting and equally aggressive efforts to boost revenues at divisions whose fate is less tied to commodity prices, rather than on gains from a stronger economy. At best, Alcoa’s results are sending mixed signals.
In fact, while the broader market is staging a bit of a relief rally this morning in response to the better-than-expected news from Alcoa, the key takeaway from Alcoa’s report is that this is a quarter where earnings surprises can be categorized as "not quite as bad as we had expected" rather than by how solid they were and how upbeat comments from management were during the conference call. That’s an important shift.
For stock prices to continue to zoom higher long-term, and investor anxiety to abate, positive earning surprises have to fall into the latter category. Analyst expectations for results at most S&P 500 companies have been steadily scaled back over the course of the first quarter, and beating a lowball number is less of a feat than clearing a higher bar. After all, Alcoa’s profit – however pleasant a surprise – was a fraction of what it was in the first quarter of 2011.
The big unknown is how much of this still-bearish outlook is baked into stock market valuations at their current levels. It has been clear for some weeks now that first-quarter earnings results were going to fall significantly short of the kinds of double-digit gains recorded in recent periods. But investors are now actively seeking out the bad news, to justify their nervousness after months during which the stock market has rallied with tremendous consistency, and rewarded us with the best first-quarter performance in well over a decade.
That translates to a lot more noise and volatility surrounding each significant earnings result that hits the headlines. It’s more important than ever before to be prepared to stick to your guns, to be confident that you own a stock you’d still want in your portfolio even if someone tells you it’s about to fall 10 percent due solely to market noise or in a kneejerk reaction to an offhand comment by a CEO during an earnings conference call.