Here’s How Earnings Reports Are Shaping Up

January 26, 2004
Chris Curran

The major indexes took a breather last week,
with the SP 500 squeaking out a small gain and the Dow snapping its eight-week
winning streak. Despite the negative finish, the overall declines were minimal,
while breadth stayed firm. Most likely, simple profit taking took place, given
the large run-up weâ€™ve seen since early December. Telecom equipment shares took
the worst of the pullback, which many blamed on AT&T‘s
(
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PowerRating)decision to reduce capital spending plans for 2004. This news seemed to
buck conventional wisdom, where market players had been expecting a dramatic
increase in spending by many of the large telecom companies. Also under
pressure were various cyclical/industrial names such as Dow components
3M
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PowerRating) and
Honeywell
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PowerRating), which sold-off following their earnings
reports. When excluding currency gains (i.e. the weak dollar), many of these
large multi-national companies’ top-line growth figures left a lot to be
desired, especially with the valuations many of these companies have. Overall,
though, the major indexes were due for a pause and that’s exactly what happened
last week.

The March SP 500 futures closed
Fridays session with a loss of -3.75 points, but still managed to finish the
week with a +2.25 point gain. Volume in the ES was estimated at 641,000
contracts, which was ahead of Thursday’s pace, and above the daily average. On
a longer-term basis, the cash SPX remains shy of its prior monthly and weekly
highs and Fib resistance in the 1,164-74 area, but just above its 200-week MA at
1,127. Looking at the daily chart, the March contract broke its rising wedge
and bounced off its 10-day MA support at 1,134.

With two
of the busiest weeks of earnings season now behind us, it might not be a bad
idea to take a look at how earnings reports overall are shaping up. Without
question, profits are continuing to rise, even when using more stringent
accounting methods. It’s true that a large percentage of the earnings gains
continue to come from cost cutting measures, which has been confirmed by the
large gap between earnings and sales growth. At the same time, many companies
have been starting to suggest that corporate spending is picking up. If this
turns out to be true, Iâ€™d expect earnings overall to continue trending higher
through Q3. Another positive for profits and guidance has been the low interest
rate environment. Lower rates have allowed Financial companies to produce
strong results, and consumer-sensitive sectors such as Retail have been able to
hold their own, despite the common perception that the sector was going to
breakdown a few weeks back. And finally, China continues to remain a huge
positive for American companies, as the Chinese economy continues to hit on all
cylinders.

So far
this earnings season, the positives have outweighed the negatives, but there
have been some warning signs also that we should note. First, in many cases
large multi-national companies, such as 3M (MMM), have suggested that end demand
in the U.S. remains lackluster. Without currency gains and strong demand in
Asia, sales growth would have even been negative in some cases. This then
raises the question, â€œIf the recovery is on solid footing, as most on Wall
Street now believe (or last least they say they do), then why is demand so
lukewarm in the U.S.?

^Next^

Another
concern about this earnings season has been the issue of a very large inventory
build-up benefiting much of the Chip sector. More than 1 company has even
hinted that visibility a few quarters out remains very uncertain because of the
possibility of a large inventory glut. In other words, ordering increased
significantly in Q4, which is currently allowing many companies to report
outstanding numbers. However, there has been a lot of talk that end demand has
started to slow, which could leave many companies with too much inventory on
hand. If this is the case, there could be some serious problems a few quarters
out in the Tech sector. So, at least at this time, it’s still too early to tell
for sure how spending is shaping up, since conflicting reports over inventory
levels/end demand continue to be seen. Nevertheless, weâ€™ll be seeing further
clues coming out in the weeks ahead, and we’ll want to be watching these reports
closely as they unfold.

While
earnings season continues this week with a heavy flow of reports, and January
Consumer Confidence scheduled to be released on Tuesday morning, the main focus
will be on Wednesday’s FOMC meeting. Rates are expected to be left alone, but
Fed-watchers will be siphoning through the Green-speak for any hint of when a
rate hike may be coming.