In reading an intense piece of research from JPMorgan during the weekend, I wondered if the average investor was making the proper linkages amid the arrival of the latest earnings season. There are two tiers of information, as I like to think about them -- and both are far removed from the information gained by Bud Fox's methods in Wall Street.
The first is the "granular" stuff that we, as supposed market masters, digest daily in order to select butt-kicking stocks for clients. For example, there were a couple useful #NerdyNuggets that I extracted from the aforementioned JPMorgan research note, and they included the following.
1. Wall Street's estimates (aka the sell side) have been reduced by 2% in 90 days' time, thus matching the trend into earnings season in the preceding four quarters. I take this as continued over-exuberance on the Street that points to elevated downside risk to stocks as earnings season spins its forceful winds. Why? The answer is simple: Demand unexpectedly fell in the second quarter (toward the end of the quarter for many), which was the complete opposite of the prior four quarters' circumstances. Second-quarter 2012, therefore, may spur the need to break from trend and drop third-quarter earnings estimates more than 2% beforehand, assuming things stay constant.
2. Thus far, the magnitude of earnings beats for consumer cyclicals have shrunk relative to the post-recession trends. I read this as risk to second-half outlooks in cyclicals, as consumer spending has only recently moderated. Plus, we're seeing dwindling percentage earnings beats against lowered estimates. It doesn't exactly engender confidence.
The assessments I have made above, for which I've used tier-one data, could prove completely wrong. I just wanted to share the linkages that I've been constructing.
What if you lack access to this fancy information that I have discussed? It's OK -- building an understanding of the microenvironment and applying it to market sentiment, which is very important amid an earnings season, is easily done. In order to go about it today, simply group together economically sensitive companies and whittle down the concerns (or positives) that you see in the marketplace up to this point. Then, ahead of their earnings for railroads Kansas City Southern (KSU) and CSX (CSX) this week, dissect the companies in a manner similar to how I did.
Railroad Musings
Pricing: The economy has softened and, along with it, pricing power. Railroads have enjoyed strong revenue gains from price increases for a while already, masking the volume weakness that crept into the picture in the first quarter. Anything other than strong pricing by railroads would support the sentiment of the bears in the market, and it would likely trigger a selloff in the sector. That's because a key trend, pricing, will have been rising at a slower rate. (I don't think it will outright decline, as railroads offer an efficient way to move goods). By the way, if volume was lackluster in the first quarter, it could be a story that overtakes continued success on prices.
Performance in focus areas for the market: European debt crisis contagion has arrived at U.S. shores. I have seen it in numerous economic and corporate reports for months on end. As a result, I don't necessarily care how Kansas City Southern and CSX performed in their automobile segments -- we are aware that persistent strength in auto is having a halo effect over many industries. Instead, I will dive into volume trends in the metals, scrap and food and consumer segments. In a nervous Nelly market, the good events will be overlooked and the bad events will be viewed as still not being properly priced into the stock. Know those potential corporate financial pain points.
