Fisher Investments Editorial Staff
Corporate Earnings

Tuning Out the Static

By, 07/14/2010

Story Highlights:

 

  • Corporate profits have been exceptional in the past two quarters.
  • Lean and mean companies combined with continued economic growth should maintain that strength this quarter.
  • Earnings season starts in earnest next week, but early reports from economically sensitive firms were encouraging Tuesday.
  • Perhaps another solid earnings season is all investors need to tune out the gloomy chatter for a bit.

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(Editor's Note: MarketMinder does NOT recommend individual securities; the below are simply examples of a broader theme we wish to highlight.)

 

There's a boatload of speculative static on the stock radio right now. Lost in what may happen in Europe (seemingly less and less, day by day) is what is (and has been) happening with corporate earnings for a couple quarters now—profits are booming.

 

How does it work? Simple. Economic growth boosts revenues which has a hugely positive effect on earnings for still-lean firms. Earnings add to corporate piles of cash (also historically high at the moment), heralding huge capital expenditures as sentiment turns. Returns on business investment should further juice earnings down the road. All this, against a backdrop of cheap stock valuations—the S&P 500 forward earnings yield is 8.0% compared to 2.9% on 10-year Treasuries*—is promising for stocks looking forward.

 

But this isn't just a guess at what's to come. Earnings growth overall has been spectacular for the last two quarters, stomping expectations by a historically wide margin. Q4 2009 S&P 500 earnings checked in at 206% over the depressed prior year, and Q1 2010 chalked 58% earnings growth. As annual comparisons get a little harder, don't be surprised if these bounce numbers come down a bit—as we've noted before, that's typical in a recovery. But look for continued solid and, most importantly, expectations-beating numbers for the foreseeable future.

 

Earnings season starts in earnest next week, but this week's smattering of reports may offer a tale of what's in store. Economically sensitive firms Alcoa and CSX were among the first to report, and both beat expectations, helping send stocks higher Tuesday. Alcoa makes aluminum, used the world over for capital-intensive growth projects, like infrastructure in Emerging Markets. Better than expected earnings show little sign of the feared slowdown in China and elsewhere. CSX is an East Coast freight "rail giant" that transports the stuff our economy consumes when it's chugging along. Thirty percent of CSX's revenues are tied to coal transport—CSX's coal shipment revenues were down in the Q1, but up in Q2. Higher energy consumption is a great sign of improving economic activity.

 

Commentators have lately been calling the economy "depressed" and "sluggish." But unless you've got blinders on, fixating on one or two dour stats, neither term fits reality particularly well—especially earnings. Country-wide earnings (not just for the S&P 500) have already surpassed their previous peak in 2006, according to the St. Louis Fed. That doesn't smack of an economy bumbling along the bottom.  

 

Markets were up solidly Tuesday in the face of a Moody's downgrade of Portuguese sovereign debt—just a month ago this would have sent stocks sliding. Perhaps another solid earnings season is all investors need to tune out the gloomy chatter for a bit. We expect profits to continue their win streak, and for stocks' bottom line, that's all that matters.  

         

* Source: Thomson Reuters, Bloomberg; as of 6/30/2010

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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