Once again Barry Ritholtz provides some timely information on market conditions, with a look at the current earnings season. The chart showing the stock price reactions is most informative. Barry's explanation, however, is not very persuasive. First take a look at his data:
Link: 1. Earnings 2. Reaction 3. Guidance.
We are about halfway through earnings season, and it looks like another quarter of double digit year-over-year earnings growth. This now makes something like 14Qs in a row. That's the good news. To a large degree the market has already priced in these …
Barry looks at the market reaction and sees evidence that things will get worse. He points to the guidance that companies provide as confirming this idea.
Here's the real story.
Look at the other two worst quarters judged by stock price reaction after the report: Q1 05 and Q2 04. I remember both of them well, and the pattern is familiar:
- Analysts covering individual stocks of a cyclical character have been trying to call an economic top for 2 1/2 years. They have been completely wrong about stocks like Caterpillar, Ingersoll Rand, materials stocks, and many others.
- Market "strategists" have been looking for a recession in every data point since the election-year debates over employment growth. They have been completely wrong in predictions about consumer and business spending.
- Rookie hedge fund managers, overly-influenced by the 1999-2000 bubble years, are eager to be contrarian. They want to be the first to spot a market decline. They have also been wrong.
You can see this by looking at the actual market reaction to corporate guidance. When CAT executives say that business is great, global prospects are excellent, and they are only midway through a growth cycle, their report is viewed with skepticism. Some firms even raise earnings estimates while lowering price targets.
Barry calls this the cycle of multiple compression. I say it is trying to guess the top -- and doing it without good evidence.
When guidance is less than perfect, you get something like the UPS fiasco. A company adjusts guidance based on consensus economic forecasts and the market interprets this as evidence that the consensus forecasts are too high!
The skepticism toward both analysts and reporting companies is excessive. It has been wrong for several years now. This Wall Street error provides an opportunity for investors who have confidence that the fundamentals matter.
