Earnings Don't Tell the Whole Story

07/25/2012 11:30 am EST

Focus: STOCKS

Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

Increasingly, as quarterly earnings become more important to the markets, the big companies are finding ways to dismiss weak earnings—and their implications, writes Ian Wyatt of The Daily Profit.

This earnings season is off to a fast start. Yet you wouldn’t know it by tracking the market.

We’re only about one-fourth of the way through second-quarter earnings season, but so far most companies have reported profits that exceeded consensus analyst expectations.

Of the 118 S&P 500 companies that had reported through Sunday, 73% beat estimates. That’s well above the historic average of 62%, and not far off the record 79% earnings beats set in the third quarter of 2009.

And yet stocks have fallen slightly since Alcoa (AA) unofficially kicked off earnings season on July 9.

We’ve seen this before. Lately, in fact, it’s been the norm.

First-quarter earnings were even stronger, with roughly 75% of the S&P 500 beating forecasts. But the strong earnings did little to boost the market.

From April 10 through May 18—when nearly every major company reported first-quarter earnings—stocks fell precipitously. The Nasdaq declined nearly 9%. The S&P 500 dropped more than 6%. And the Dow Jones Industrial Average slumped more than 4%.

In fairness, a long-overdue market correction was partly responsible for the pullback. The first four months of 2012 brought double-digit returns and four-year highs for US markets. The Nasdaq even eclipsed the 3,000 level for the first time in 11 years. Stocks simply were not capable of rising much higher no matter how strong the first-quarter earnings were.

Now that stocks have fallen back to their early February levels, one might expect that the strong start to the current earnings season would translate into another rally. But these are no ordinary times. The economic data—both in the US and especially in Europe—is simply too weak for an extraordinary amount of earnings beats to overcome.

Investors are too concerned with high unemployment rates, near defaults in Greece and Spain, and two more years of near-zero interest rates to care much for earnings reports right now.

Besides, the latest earnings aren’t actually as strong as they appear. Yes, for the second straight quarter roughly three out of every four companies is beating earnings forecasts. But as we’ve said before, it’s easy to beat earnings forecasts when expectations are so low.

Take the banks, for instance. Five of the six major US financials beat estimates last week. Yet only Bank of America (BAC) and Wells Fargo (WFC) actually grew their profits compared to the same quarter a year ago.

That was a virtual repeat of what happened in the first quarter, when all six big banks beat expectations despite only one of them—Wells Fargo—growing its profits year over year.

Financials aren’t the only sector where earnings expectations are low. Tech giants Intel (INTC) and Microsoft (MSFT) also managed to beat second-quarter earnings projections despite sharp year-over-year declines in profits.

Wall Street has set the earnings bar very low. No wonder so many companies are clearing it. And it seems investors are growing numb to all the earnings beats. Who can blame them? It’s hard to get too excited about a few glowing earnings reports when all the other economic data is so grim. 

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