Earnings confusion

While the three major market indicators all closed higher for the week, there wasn’t a lot of strength to the moves as the traders were waiting to see what the earnings for the various companies reveal. Those reports start increasing this week and will peak over the next couple.

As has been the case since the financial crisis began, the main concern among investors is that economic growth will falter. Consistently over every quarter since the recovery began, there have been many doubters about the strength of US corporate earnings…and sure remains so now.

I guess they believe that because the combination of a slowdown in global economic growth and the strong dollar, a bit of near-term earnings and momentum headwind has been created for the stock market. Some investors fear the dollar will wreck our recovery before it helps lift overseas economies. And it’s true that the strength of our dollar makes our exports more expensive and therefore less competitive in the international marketplace. This has depressed some corporate earnings expectations and will likely continue to do so for a while.

According to FactSet, “The corporate earnings outlook for 2015 is bleak, as first-quarter earnings for the S&P 500 index are expected to come in 4.7 percent lower (than a year ago), while second-quarter earnings are expected to be 2.1 percent lower.” In addition to the dollar strength, economists are blaming hits to earnings on falling oil prices, which beat up energy company earnings, and weak economic growth world-wide, which can reduce corporate sales.

I want to caution you to not get all caught up in this earnings-expectations game. It’s not such a big deal if a high-quality stock misses earnings in any one three month period. What you instead want to focus upon what the trend of the company’s business is doing. By definition, weekly, monthly, or quarterly data is much more volatile than the trend. A long-term investor shouldn’t be bothered by short-term gyrations…

However, a strong dollar also has some positive, long-term effects. Here’s what I mean.

Dollar has positive and negative effects

All we hear about is the negative effect of a stronger dollar on our multinationals operations for products manufactured here and sold abroad. But what about those products they manufacture and sell abroad? In some cases, one cancels out the other and the result can be a more positive outlook.

If you own a US-based multinational, and you worry the stronger dollar might hurt their overseas revenues more than it helps cut their import costs, you probably want them to do what’s necessary to protect profitability. Trimming expenses, focusing on those involved in boosting productivity, while not trimming output could be a logical response. Mergers and acquisitions can also come into play here.

As Alcoa demonstrated in releasing its earnings this past week, many companies having operations in other parts of the world will benefit from “favorable weaker currencies” on top of lower energy costs and any productivity improvements.

And here at home, a real benefit is that the strong dollar tends to boost US consumer spending.

The trend

A quarter does not a trend make. The other major markets seem to understand this as, despite all the hot air about our earnings, the stock indices in Frankfurt and London finished last week at records. Shanghai and Hong Kong were at post-2008 highs.

Earnings, like the jobs data, are trailing reports, i.e., based on old news. Many of our economic figures have already turned back up, thanks to more normal weather, the end of the port strikes and oil prices that appear to be leveling off. Since stock prices typically move on expectations for the coming six to nine months, making them a leading indicator, many experts anticipate stock gains…despite lower first-quarter data.

With long-term interest rates (20 – 30 years) looking to not be going up much and likely staying relatively low for some time, stocks in general, and especially the dividend-paying kind, are still quite attractive for longer term investors.

The United States is the world’s largest national economy with a GDP of approximately $16.8 trillion. Given the size of our economy, do you really think an earnings squiggle is going to throw it off track? It’s like dropping a rock into the Columbia River and expecting the river to be diverted by it…

Let me know if I can be of help to you in reviewing your current holdings.

PS No letter next week – I’m going to be in Williston, ND, to check on what’s going on in the shale oil fields. Hopefully, we’ll have some content for a future piece as a result of my trip…

Cheers!

Mike

Securities and Investment Advisory Services offered through KMS Financial Services, Inc.

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