- - Thursday, April 21, 2011


As tends to be the case during corporate earnings season, the stock market was volatile but all three major indexes are on track to finish the shortened trading week higher than it ended last week. While corporate earnings have been as strong as I suspected, I have to acknowledge that I am more than a tad surprised by the market strength given Standard & Poor’s revised long-term credit rating outlook for the U.S. from “stable” to “negative.”

Of course, that is the nature of earnings season as the market tends to be swept up by the latest news and earnings beats or shortfalls. In this case, it’s the number of companies reporting either better than expected quarterly results or increasing respective near-term forecasts that has fueled the market move on Wednesday and Thursday.

Or has it?

According to data compiled by BeSpoke Investment Group (BIG), the earnings “beat rate” — the percentage of companies beating earnings estimates — this earnings season is not looking so great. BIG estimates that 64 percent of U.S. companies have beaten earnings estimates so far this earnings season. That sounds like a pretty good number on its face, and a quick scan of the headlines confirms this ratio. For every Apple, Qualcomm, W.W. Grainger, United Technologies and Eaton Corp. that shattered expectations, there are those, such as Badger Meter, Marriott, Harley-Davidson and others that missed expectations.

To put BIG’s 64 percent calculation into context, it would be the weakest earnings beat rate since April 2009, but still ahead of the 62.5 percent level the beat rate has averaged since 1998. To be fair, it is still early in the cycle for March earnings, but BIG’s work has revealed that the beat rate tends to drift lower from the beginning of earnings season to the end.

BIG goes on to point out that while an earnings beat is generally a good thing, the “price reaction to the report is the ultimate arbiter of whether the report was good or bad.”

In other words, was the earnings beat expected or not? Did a company’s earnings beat fall below what those on Wall Street thought the company was capable of delivering, or as it is known “the whisper number?”

With a few weeks left, I will keep my eye on the earnings beat rate to see whether that historical downtrend continues.

Other than corporate earnings, we’ve received a number of data points in recent days that continue to suggest a mixed economic recovery. While there are bright spots such as industrial production, the Empire State Manufacturing Index and others, we continue to see oil and gas prices tick higher, the Philly Fed Index for April significantly miss expectations, companies such as McDonald’s warn of food inflation and weekly jobless claims back to more than 400,000 for the second week in a row.

With regard to inflation, McDonald’s now expects food costs to rise between 4 percent and 4.5 percent in the United States and Europe in 2011, up from 2 percent to 2.5 percent in the United States and up between 3.5 percent and 4.5 percent in Europe as it said in January. J.C. Penney CEO Myron “Mike” Ullman shared this week that higher cotton prices are a major concern for apparel retailers, which are likely to increase clothing prices anywhere from 5 percent to 20 percent after holding steady for about two decades.

To me, these last two data points are meaningful because they not only reinforce the notion of inflation, but also make me wonder how long it will be until other restaurants and apparel makers begin implementing price increases. The next logical question is how long until this is felt in the Consumer Price Index. Bear in mind that already in the past 12 months headline CPI is up 2.7 percent before seasonal adjustment, according to the U.S. Bureau of Labor Statistics.

Despite the corporate earnings beats, what I find more worrisome in the near term is the lack of real wage growth, a negative trend in inflation-adjusted disposable income and a 19.3 percent underemployment reading per recent Gallup data at a time when all of the major stock market indexes are at or near three-year highs.

In my view, there is increasing risk to the consumer and consumer spending and whether improved corporate spending can offset what may turn out to be weaker than expected consumer spending in the coming weeks and months. Better-than-expected earnings this week by several major technology vendors, such as Intel, IBM, EMC Corp. and VMware, suggest a rebound is under way in corporate IT spending, but consumer spending accounts for the lion’s share of our economy.

Stay tuned.

Chris Versace, the Thematic Investor, is director of research at Think 20/20, an independent equity-research and corporate-access firm in the Washington, D.C., area. He can be reached at [email protected] At the time of publication, Mr. Versace had no positions in companies mentioned; however, positions can change.

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