The Day Ahead: A Cold Splash of Reality

 | Mar 21, 2012 | 8:30 AM EDT  | Comments
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A wise old owl in this industry once told me: "Son, you have got to always have an opinion one direction or another." That rule of thumb has guided me through the years, from walking a tightrope on a stock call pre-earnings or just listening to a gut feeling on the broader market, based on how certain indicators flash across the screen.

I must admit that the opinionated path is tough to adhere to. That's especially so when your email inbox gets flooded with analyst notes that, at the root, are hedged to the point at which a buy rating could seem more like a sell rating after you digest the fancy analysis. Sitting here today, I find myself being yanked into the grey zone on the market's near-term direction, and that could either be good or bad, depending on which camp one calls home at the end of the trading session.

The "Sort of" Good

Waking up to another wrinkle in whatever kind of China growth slowdown is taking shape (hard, soft, feather landing on a pillow, concrete boot dropped from a bridge, etc.) set the stage for the initial pullback in stocks Tuesday. Yesterday, it was the hike in gas prices. Still, the retrenchment was not the stuff of panic: Basic materials, industrials and other sectors leveraged to China's growth miracle all held their ground.

Then Rio Tinto (RIO) emerged from the homestead and essentially echoed BHP Billiton (BHP) on China iron ore demand. Sprinkle in the miss on housing starts, and I thought for sure the session would take a turn for the worse. (As I hinted at Tuesday morning, you need to pay careful attention to whether macro data managed to beat heightened forecasts. Starts didn't, and homebuilder stocks bore the brunt.)

Alas, no dice on the worst-case scenario. A good percentage of stocks I watch in the aforementioned sectors experienced mere indiscriminate selling, as opposed to fear-based gap downs.

By the way, here's the good news: For the market to reverse course it would require definitive evidence that the U.S. macro picture is poised to unwind improvements made since the summer of 2011 -- for instance, in housing, jobs, and so on. Not even mighty China, despite its potential impact to corporate profitability from, and the continued repercussions of the eurozone derailment, could overthrow the bulls.

The Real

Still, as I reread the above, it's apparent that the assessment of the good has been hypothetical or, as it's called, "data spin." Since dealing in facts is usually a sure-fire ticket to having a happy life -- if not necessarily a happy investing career -- here are a couple of realities:

1. Multinational companies are continuing to press ahead with their China expansion plans, and they're paying top dollar to do so, yet growth is being downgraded right before our eyes. Given this, shouldn't the market assign a higher-risk premium in determining valuation? I scour sectors and do not see the adjustment mechanism at work.

2. Allow me to expand upon my Tuesday discussion on profit margins. Fourth-quarter S&P 500 profit margins, excluding those in financials and utilities, declined 27 basis points sequentially, or 52 bps minus Apple (AAPL). Looked at from another perspective, earnings per share in the majority of sectors of note grew more slowly than sales did -- and that was before all of the hoopla regarding escalating fuel expenditures.

The Young Owl Assessment

I am in search of new reasons to be bullish on the market. Yes, companies are sitting on loads of cash. Something called a long-term refinancing operation (LTRO) saved the eurozone, even though it's doubtful as to whether it'll help pare Spain's unemployment rate. China is the "best shirt in a dirty hamper," the trailing price-to-earnings multiple is below a historical average for U.S. shares, and employment trends are on the mend, though open to different interpretations.

However, I want to be wooed a little bit. My expectations are modest. It could be a positive first-quarter pre-earnings announcement from a multinational that originally guided below consensus. It could be stronger wage growth in the March employment report (Costco (COST) is limiting overtime, which is interesting.)

Until then, though, I believe it's worthwhile to buy growth names on dips, provided keys support points are convincingly held. These will be the companies that'll have the ability to circumvent the fray that continues to exist in the global economy.

Inside Edge: Learn from Boring Earnings Releases

Earnings reports from consumer staples could be boring if taken on face value. They're long, the terminology is slightly silly, and they're honestly devoid of the fun that exists in shopping for the products the companies sell. But that doesn't mean you should toss these reports in the garbage can and scurry along. Quite the contrary: General Mills (GIS), for example, is always a prime report from which to pick derivative ideas. That's because, if nothing else, 20% plus of the company's annual sales result from the graces of the tight-wallet buyers at Wal-Mart (WMT).

Focus on the list below while reading over the earnings from General Mills this morning, and remember these points:

  1. Higher fuel outlays + increased promotions = bad sector and derivative play setup
  2. General Mills will be reporting against a February earnings warning.

Marketing: Something I began seeing in the middle of last year, and on into the first quarter, has been increased marketing to drive sales, even if comes at the expense of profit margins. (See Tiffany's (TIF) earnings Tuesday, too.) General Mills has been no exception to this broader trend. If marketing is heavy, I would begin to do the research on Omnicom (OMC) instead of IPG (IPG) and WPP Group (WPPGY).

Consumer story: The Pillsbury segment, which houses such eat-at-home brands as Totinos, logged a 9% sales increase in the previous quarter. Acceleration in sales, or a steady sequential growth rate, could indicate a shift in consumer-buying behavior that won't necessarily be reflected in consumer-confidence measures.

Restaurant stocks: General Mills distributes products to restaurant accounts, and this part of the business had a solid 12% sales gain the prior quarter. I am looking for signs of a slowdown here as vendors order less inflationary products to go alongside more volatile traffic trends. This, by the way, is related to consumers consolidating trips and limiting discretionary expenses.

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