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Lebron James and Earnings Season
By: John Petrides, Growth Portfolio Manager
Date: 7/7/2010
Let's get on with it already! Weeks of permutations and combinations as to where everything will shake out are finally coming to a close. So many blogs, rumors, and speculations as to the outcome and the future have been plastered on every media channel possible, that clarity has finally arrived. As a New York Knick fan, I hope Lebron James comes to Madison Square Garden, but what I was referring to was the upcoming earnings season. On July 12th, Alcoa will officially kick off the second quarter in what I believe will be a pivotal round of earnings. Why? A number of key macro data points have been presented over the past six weeks suggesting the economy is GROWING, but slower than consensus expectations. I emphasize growing, because the markets are acting as if the economy is not growing, when in fact it is simply not growing as fast as some people have come to think.
It wasn't long ago that almost everyone expected the recovery to be sluggish and well below historical patterns. Some people upgraded their forecasts as the recovery first unfolded. (Others suggested the recovery would not last and the economy would relapse into recession.) Now, it appears that everyone is reducing their expectations for the economy. The stock market, a discounting mechanism, is responding accordingly and suggesting that analyst's 2011 earnings expectations are too high. However, the market is now trading at a price-to-earnings multiple near that of March 2009 market lows, when the structure of the global economy was in question, the credit markets were still frozen, and corporate balance sheets had not yet begun being repaired, a far cry from where we are today. This does not seem appropriate.
I am anxious for the earning season to begin, because it will be helpful to investors for management from all sectors of the economy to actually put the European debt issue into context, to update consumer traffic patterns for shopping, to talk about commodity cost trends, and to highlight inventory and pricing efficiencies, etc. I am also looking for companies to enhance their balance sheets by paying down debt and managing inventory, and also return cash to shareholders in the form of share buy backs and dividends. This will provide a useful counterpoint to hearing and reading speculation from all of the talking heads across the medium spectrum how Greece and fiscal austerity will undermine our economy.
Fundamentals relative to expectations is an essential part of navigating through the equity market. As Warren Buffet and Ben Graham teach, the quest for value is to find good businesses at cheap prices creating a margin of safety. In other words, become investors in a business, where investors/analysts are underestimating earnings growth and its potential. In this environment, investors should be looking for companies whose expectations are "washed out" with muted earnings growth and p/e multiples trading below that of the S&P 500. There are many such opportunities available today.
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