I think it's safe to say that Quantitative Easing is considered a market crutch by many, but now that we know it's coming to an end, why aren't stocks crashing? Could this market actually support itself without the Fed? Perhaps...
Headlines can be scary. Think about the events that have taken place in the first part of 2013. We went "over" the fiscal cliff, hiked taxes on Americans and began making automatic budget cuts via the sequestration. Then the FOMC indicated that they intend to slow monthly bond purchases (QE) sooner than later, meaning that $90 billion in monthly bond buying will just go away ... and yet stocks are holding their ground.
What's even more fascinating (and somewhat scary) is that estimates for earnings growth have come down to 1/10th of what they were just three months ago. Q2 earnings season was supposed to be almost 4% better than last year and now analysts are only expecting the S&P 500 to add 0.3% to their bottom line year over year.
Despite the drawbacks and reductions in estimates, stocks have managed to add over 18% year to date.
Why? Because there is not only value left in many stocks, but an underlying hope (bullishness). The fact is that the U.S. is still the best place for global investors looking for a place to park their hard earned dollars, and investors are even looking beyond QE to see bullish potential.
More . . .
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Still Not Euphoric
If markets were completely euphoric and irrational, then we should have seen a 10-15% correction without a bounce after the FOMC's last statement.
There are 14 stages of investor sentiment; these variations can be fairly easy to spot at times and elusive at others. Stocks often trend depending upon the psyche of investors, not always on hard fundamental data.
Interestingly enough, there is clarity amidst the chaos. As we entered into the New Year, there was doubt and markets were cautious, but stocks still managed to charge forward.
"Hope" was the best way to describe the marketplace back in January, which was fairly close to the point of maximum profitability in the market's emotional cycle (see the chart above).
If we take a look back to mid September 2012, markets were completely euphoric running up into the elections, with the fiscal cliff just a twinkle in the eye of only the savviest investors. After the election results and woes about the cliff and future of the economy, the market quickly gave back 9%, changing the mood from elation to outright depression.
Over the last six months, we have watched market sentiment go from a state of panic and then completely turn around. In fact, if you look at a daily chart of the S&P 500 over the past 3 months, you can see these emotions play out in stock prices.
At the start of last quarter's earnings, stocks had run up into the "Thrill Zone," but took a break, gathered some rationale and reset themselves back into what seems to be more hope than anything, especially given the FOMC's announcements.
Managing Earnings Expectations
While emotions can rule the markets much of the time, there are four times a year when stocks report their results (earnings) and the objective overtakes the subjective. If the subjective mood is not "overly euphoric" than stable objective data should cause stocks to rise; this works in the opposite direction as well of course.
The good news is that markets are NOT euphoric or even overly optimistic when it comes to MOST earnings expectations. In fact, stocks are perhaps more realistic now than at any other time this year, BUT you must be able to identify those stocks that have built up such a high expectation that it may be impossible to deliver.
I'd be lying to you if I said that corporate revenues are shooting up and that the average company is making money hand over fist. But I can say that there are three things that I feel very good about in the first half of 2013:
1) Corporations are lean and mean - The average American company has cut costs and economized their businesses to keep margins high and operate in a low growth environment. Margins are still expected to be on the rise year over year.
2) Hoards of cash - We are seeing many companies stockpiling cash and equivalents, preparing themselves not just for the worst, but for the turn. The turn being an improvement in the economy and post QE prosperity; that cash is utilized for expansion, M&A, share buybacks and dividends.
3) Expectations low - As I mentioned last quarter, expectations were relatively low, but more recently the average share price and growth estimates have come down even further. This makes the reaction to a positive surprise that much more significant.
Even though Q12013 earnings weren't the strongest, stability and moderate growth were enough to propel the right stocks higher. Despite the less than stellar results, my earnings service actually had one of its best quarters.
These factors will help support the markets throughout the coming earnings season, as long as revenues do not fail miserably.
How Do You Trade Q2 Earnings?
Expectations are low for a reason. I wouldn't expect the overall market to see as good a return in FY2013 as we saw in FY2012. There will be "headline risk" associated with Europe, China and the speed at which the Fed tightens here in the U.S., which will also keep volatility elevated this summer.
This means that you have to be laser focused and step outside the box to find alternative investment methods that capture superior returns. Defensive stocks and utilities are not in vogue and even stocks with low multiples aren't going to necessarily be safe havens if their reports are weak. Not all stocks are rising in this bullish market.
To get the edge, I target and study analysts' behaviors and actions ahead of a report to sniff out those companies most likely to beat earnings expectations. I compound that data with relative valuation and sector favorability to find high stocks with a high chance of not only beating estimates, but moving higher on that news.
The perfect way to add this type of diversity to your portfolio is to target companies likely to beat analysts' estimates and keep the trades short in duration so you won't be over-exposed to a market that is still susceptible to headlines.
The bottom line is that we will still have companies that perform extraordinarily well and top analyst expectations this coming earnings season. These companies will see their share prices break away (positively) from the market average as they attract new money looking for yield.
The "shotgun investing approach" will NOT work this season as I believe the big winners will be few and hard to target with a still doubtful market.
You will need an effective tool to do this; one that stacks the odds in your favor. Whatever method you choose, be sure to allocate your assets appropriately, reduce risk where needed and take or protect profits once you have them. This will certainly be another tough quarter for the average "long only" investor.
Listen to the Right Whispers
I am directing a Whisper Trader service that uses Zacks research data to predict positive earnings surprises before they're reported. It has greater than 82% accuracy in selecting companies that beat estimates. Although these "surprise" stocks don't all turn out to be winners, listening to selected whispers obviously can give investors a substantial advantage.
If you would like my specific stock recommendations, they are now available in the Zacks Whisper Trader, which is open to new investors until Saturday, July 13.
Learn more about Zacks Whisper Trader.
Happy Trading (and don't forget to hedge),
Jared A. Levy is one of the most highly sought-after traders in the world and a former member of three major stock exchanges. That is why you will frequently see him appear on Fox Business, CNBC and Bloomberg providing his timely insights to other investors. He directs the Zacks Whisper Trader, which has an uncanny record for accurately predicting robust earnings before companies report.