Thursday, July 23, 2009

Earnings Season Progress: Perception vs. Reality

The lunatics are back in charge. First we had Meredith Whitney upgrade Goldman Sachs. She was rather cautious on the fundamental prospects of the banking sector, but did anyone care? No.

Next, we learned that Meredith has a pretty good contact at Goldman as they reported a blowout quarter. Of course, they're benefiting from the "unfortunate" demise of a few of their key competitors which has resulted in widening spreads and terrific near-term trading profits. How many other large "banks" will benefit from this? A couple. Commercial and residential loans continue to deteriorate. Does anyone care? Not really.

Intel followed. Nice quarter. Revenue was better than expected which helped boost gross margin. Of course, Intel is at the back end of the supply chain and not the best company to listen to when it comes to tech industry guidance (I'd happily wager that they guide down revenue before their next report). We also just learned that AMD posted a fairly poor quarter, so Intel clearly benefited at the expense of a key competitor. That's a different story than a general tech rebound. Does anyone care? Doesn't look like it.

Apple was next to release. Not surprisingly (they always guide low), the company posted a strong quarter with particular strength coming from iPhones. Despite the recession, this is clearly the hottest consumer gadget on the market. Does this have any bearing on technology consumption in general? Not much. In fact, it could easily be argued that the money that cash-strapped consumers are spending on iPhones and monthly calling plans is money not being spent on other products. Does anyone care? Not much.

Plenty of companies have already reported. In general, we're seeing continued weakness on the top line (revenue) with pretty good cost cutting. With analysts having low-balled estimates (at times without company guidance), we're seeing plenty of headlines heralding a slew of earnings beats. With each beat from a high-profile company, the market charges higher.

The bulls contend that corporate America will be nice and lean when the imminent rebound occurs thanks to aggressive cost cutting. Margins will rebound strongly as will earnings. We've also seen a few of the quieter bulls pop up in the media recently. Bill Miller and Mario Gabelli have just sounded the all-clear. In addition, plenty of analysts have been upgrading stocks to "Buy" on the heels of these "wondrous" earnings. Interestingly, these folks were awfully quiet earlier this year. Now that the market has jumped 35% and many stocks have more than doubled, they're telling us that it's safe to wade back in. Different business cycle, same self-serving lemming behavior.

Yes. A few large well-known companies have reported decent earnings, but these companies are not at all indicative of the earnings prospect of the S&P 500. There are unique and one-time explanations for these results, and the weaker reports of many lesser-known companies confirm this. Even the almighty Google reported nearly flat revenue growth. Where was the concern? The market barely budged.

For those of us with a less sanguine view of our economic prospects in the next few years, the continued weakness in revenue is a serious concern. Costs can only be cut so far before margins are impacted.

We've been steadily reducing our exposure to equities during this rally. We were getting paid well to incur risk back in February and March. That's no longer the case.

Does anyone care? Not at the moment. At some point, they will. Sentiment can drive the market in the near-term, but the fundamentals will eventually reassert themselves. Until then, be wary of the lunatics.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.