After a bit of soul-searching yesterday, I came to the realization that it's time to stop watching headlines and return to where it all started: research, research and research until my eyes bleed. For the last four weeks, I have been too glued to the trading screen, ingesting too many useless titles from the non-qualified and trying to live for the moment instead of projecting the future. In the spirit of that old-school me, here is what I got for y'all...
Hate to be the bearer of bad news, ladies and gents, but third-quarter earnings season is unfortunately getting underappreciated by the supremely distracted Mr. Market. Yes, a good majority of number-crunchers (such as yours truly) are doing their usual thing, dissecting each word on an earnings call transcript. However, the messages of these corporate financial statements (where are all the share buybacks?) and of the highly paid execs who oversee those financial statements are playing second fiddle to the macro.
The reason for that lack of attention should be obvious. Individual stocks are reacting to the industrial stories of the companies presenting their financials, except that in most instances those good or bad reads are not causing shares of their peers to act in sympathy or head the opposite direction.
My sixth sense for the "stuff" we call investing early on in the reporting season is that sales and margin trends have either stayed consistent on a sequential basis or eroded slightly. (This is notable for global industrials; we're seeing strength in pure-play semiconductors.) This is due in part to weakening demand in the U.S. as the year winds down. Outlooks for the fourth quarter have been in-line to flat-out missed consensus forecasts that were dialed lower compared with three months earlier (therefore the quality of the reports must be kept in mind). Even companies that have beaten and raised fiscal-year ranges are only capturing third-quarter upside instead of confirming any real continuation of trends.
On the earnings calls themselves, there remains a talk-down of business segments performing to plan or above plan (they don't want to ratchet up expectations into slowing U.S. GDP), and outlooks are cautious for the lagging portions of a company's business.
IBM's (IBM) numbers are feeding the beast. Earnings reports on a sequential basis have been softer, primarily on modest demand that is weakening toward quarter-end in the U.S. Fundamental trends in Europe, although recovering, have been a bit more stubborn than the market expected for many companies (they expected better, given how E.U. macro reports had been coming in). Good examples: Stanley Black & Decker (SWK) and PPG Industries (PPG). Goldman Sachs' (GS) sequential weakness could be expected, given seasonality and trading conditions, but at least it casually mentioned a "significant" increase in its investment-banking backlog.
As it stands, I remain steadfast in the expectation that fourth-quarter S&P 500 projected earnings growth of +9.8% will be whittled away by the sell-side analysts who are late to the party. (Those Stanley Black & Decker downgrades on Thursday were despicable. If I pulled that nonsense for clients, I wouldn't have any clients!) This leaves Fed-induced P/E multiple expansion as the lone near-term "tailwind" to equity valuations.
What I am Telling My Clients
Dot-connecting, you should be doing it today. Get outside of the damn headlines. I am doing a bunch of dot-connecting for clients so they win; as far as I am concerned, it's us vs. everyone else.
Here is an example of putting it all together. Now that we have some form of structure back in government, meaning we know what's ahead into the first quarter of 2014, the market will likely return its focus to the Fed, to data that have been on delay, and to earnings. I have been disturbed by earnings, as noted.
The next couple of weeks of U.S. data could be skewed to the downside compared with expectations. The combination of these factors points to another dovish FOMC outlook later this month, which gives way to talk of Yellen maintaining the Bernanke Doctrine well into 2014. With that, the 10-year yield should be kept under wraps.
A name to play: Toll Brothers (TOL). Catalysts: 1.) Downward bias in the 10-year Treasury, 2.) a dovish upcoming Fed meeting and 3.) upward to sideways bias in stock prices (Toll Brothers has a wealthier potential customer pool that in theory, so it may not have been that disrupted by the D.C. drama).