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Think the
market makes sense? In some ways it does; in a lot of ways it
doesn't.
That's not a complaint - just a reality we as investors have to
acknowledge if we're to have any hope at beating the market.
This idea surfaced
again as the Q1 earnings data and numbers were being crunched on a sector-by-sector
basis. Let's just say there were some standouts, some disappointments,
some conclusions to be made, and a lesson to be learned.
We'll get to
that in a moment, but first, a blog entry we want to mention....
Over the last
two months we've sliced and diced the market in a lot of different ways
- breadth, depth, TR IN, the VIX, and more. Yet, there are still more ways
to spot likely reversals. One of them is one we hadn't mentioned
yet, as we had no real-life, timely example to use. That all changed earlier
this week.
Like the rest
of our recent array of reversal-spotting tools, we can use the number
of new highs and new lows as an indication of just how stretched a trend
is (which directly correlates to how likely a reversal is).
When we sew new lows reach multi-month high levels on the 25th, it was
a pretty good sign of the bears' last hurrah. Read more about the technique
in Wednesday's bog post "Believe
That! More Evidence of a Major Bottom."
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Q1's
Mismatched Earnings Results: Opportunity in Disparity |
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What's
the ultimate driver of stock values? Most would say that earnings results
(and growth) are the most important numbers to investors - and we wouldn't
disagree. A lot of factors can have an impact though.... and the size
of their impact can vary with the mood of the market.
For that reason,
let's look at the market's sectors in detail by looking at last quarter's
earnings, revenue growth, earnings 'beats' and shortfalls, P/E ratios -
the whole shebang. We think you'll find some surprising (and not
always in a good way) numbers. More importantly, the numbers may have
you rethinking your allocation as we head into the latter half of the year.
First Things
First
 First
and foremost, know that the first quarter for the S&P 500's stocks
was much better than expected - the bar is set high. When you break it
down by sector though, there were some spectacularly good and spectacularly
bad
relative performances.
The nearby table
tells the tale, though it's a complicated one.
The big buzz
was that the financial sector's earnings indicated that things were finally
looking up here. That 201% improvement in earnings though? Keep
in mind that we're comparing Q1-2010 to Q1-2009..... the darkest hour of
the recession. The meager 7% increase in total revenue trailed the average
sales growth, suggesting that the sector still isn't back to its old
pace yet.
The surprises
went the other way too. Take technology and consumer discretionary stocks
as an example. The 90% and 93% earnings 'beat' rates, respectively, were
by far the most significant victories in the minds of investors and within
the psychology of the trading crowd.
That was certainly
helpful for consumer discretionary names - they're up 7% year-to-date despite
only a 9% increase in earnings, and despite this sector now being
the most expensive on a projected P/E basis.
Technology,
on
the other hand, posted a much better 19% increase in sales, and these
stocks are technically cheaper than discretionary stocks (and even cheap
by tech standards, with a forecasted P/E of 12.1). Their reward?
The technology sector is down 7% year-to-date. So much for "What's good
for the goose is good for the gander."
Telecom was
a big letdown, for obvious reasons. And despite the 12% loss for the year
so far (the biggest among all sectors), the forward-looking P/E is still
an expensive 12.3. We still contend telecom is under-rated and a budding
opportunity, but we specifically feel it's the small caps and wireless
names that will do the leading here. The industry's giants, AT&T
and Verizon, were the key reasons for the S&P 500's telecom sector
problems.
We could go
on, but the data is right there - you can glean the clues for yourself.
We'll just part with this nugget of wisdom, and a couple of sector-specific
calls built around it.
Expectations
Are (Usually) as Important as Actual Results
While solid
tech numbers ('beats' as well as absolute improvements) didn't help its
stocks, that may have been the exception to prove the rule.
 Take
a look at the discretionary sector and the industrials. From an earnings
growth and revenue growth perspective, both were a little sub-par [keep
in mind that the comparison to Q1-2009 for consumer discretionary names
was an easy number to top]. Yet, those two groups are the only two
to remain in positive territory for the year in terms of stock prices.
How'd they pull it off? They saw a huge - and disproportional
- number of positive surprises.
Conversely,
the energy sector actually put up the healthiest (real) earnings and revenue
growth, and they're now the market's cheapest stocks. Yet, they're also
almost the biggest losers year-to-date.
Lesson learned?Beating
(or not) estimates can be just as important to a stock's performance as
actual earnings or revenue growth is. It stinks, but there's your proof
that being exclusively married to fundamental analysis can hurt as much
as it helps. That's why we take a half-fundamental, half-technical
approach.
Eventually,
analysts will get their bearings, and you'll stop seeing a huge number
of positive and negative surprises. It can take a couple of quarters to
straighten those guesses out though, which can be really good or
really
bad for those stocks in the meantime.
The Next
Best Bets
Any actionable
clues buried in the Q1 earnings and stock performance chart? A few.
 Eventually,
the fact that energy is doing so well - despite nobody realizing it
- will boost the sector's value. If you're truly a long-termer, now's
the time to go shopping for energy stocks. Just keep in mind it may
take another quarter or two for the market to get past its fear of the
energy group, and accept the fact that these companies did quite well in
a pretty mediocre environment.
Another hidden
gem in there is healthcare. Yes, the federal healthcare overhaul probably
gets most of the blame for the weakness here - uncertainty is a stock torpedo.
Now that it's not an unknown anymore, investors should start to realize
that (1) there's been some real growth here, (2) the healthcare bill actually
offers more opportunity than liability for these stocks, and (3) there
are some undervalued names in the group.
And finally,
technology offers the best of aspects both healthcare as well as energy.....
real growth of earnings and revenues, and depressed prices. Plus,
if the number of positive surprises in Q2 is anywhere near the number we
saw from the technology sector in Q1, we'd be willing to bet the result
would be buying rather than selling the next time out.
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Updated: 8:15 pm PDT (03:15 GMT), November 2, 2010
