Girding for Second-Quarter Earnings: Time to Buy?

Girding for Second-Quarter Earnings: Time to Buy?

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As the second quarter draws to a close this month, stock investors are anxiously awaiting another season of corporate earnings reports, which will unofficially kick off with aluminum giant Alcoa sometime in mid-July.  Earnings tend to drive the stock market, so it’s worth paying attention to what the experts have been saying and what investors have been doing.

The recent spate of gloomy economic data has been on the forefront of everyone’s mind. Goldman Sachs is the latest major financial institution to slash its growth estimate for the U.S. economy, predicting  second-quarter GDP growth at 2 percent down from 3 percent.  On Friday, the International Monetary Fund cut its  estimate for full-year U.S.  GDP growth to 2.5 percent from 2.8 percent  These reductions follow a wave of revisions triggered by weak jobs data and other negative economic news.

Equity Strategists and Analysts
In contrast to the economists, stock research analysts are markedly optimistic, forecasting double-digit earnings growth in the second quarter for Standard & Poor’s 500 companies, after 16.5 percent gains in the first quarter.  Current consensus estimates for the full year call for gains of around 19 percent . Just 3 percent of 9,015 analyst recommendations on S&P 500 stocks are sell ratings, according to FactSet data reported by the Associated Press.  Even after the dismal May jobs data, most high profile equity strategists continued to argue that the S&P 500 index would be much higher by year-end.

Some recent corporate announcements seem to validate analysts’ expectations. Machinery giant Caterpillar recently saw its stock jump 2 percent when it reported robust worldwide sales in the three months ending May.  Perhaps, analysts’ bullish sentiment  reflects the advantages large companies have compared with small businesses.  For example, large companies can tap highly liquid capital markets for financing, while small businesses struggle to get bank loans.  Last week, we learned that Smithfield Foods protected its profit margins by hedging its corn costs.  Ray’s Pizza probably isn’t hedging its flour and cheese costs by trading the wheat and milk futures.

Despite what the experts are saying, investors seem focused on the disconcerting macro- economic themes and have been vigorously reducing the risk in their portfolios. According to the Investment Company Institute, investors pulled $5.5 billion out of U.S. stock funds during the week ending June 8, the most since August 2010.  The S&P 500 is down more than 5 percent from its recent high on April 29.  The CBOE equity-only put-to-call ratio, a measure of investor sentiment, indicates that concern about further declines is at its highest level since January 2009. 

Major issues that continue to worry investors include supply chain disruptions stemming from the March earthquake and tsunami in Japan, the impending end to the Federal Reserve’s purchases of Treasury securities, and the ongoing sovereign debt turmoil plaguing the Eurozone.

But stocks could rally even if earnings are disappointing, as long as those earnings exceed investors’ expectations. It’s also worth noting that investing opportunities typically are most attractive when bearish psychology peaks.  As Warren Buffett often quips, “Be fearful when others are greedy, and be greedy when others are fearful.” 

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