Why Is Wall Street So Cold to Such Hot Earnings?

You'd never know it from recent equity action, but fourth-quarter earnings season has so far been remarkably strong. The Dow Jones Industrial Average ($INDU) coughed up 3.5% in January -- its worst showing in nearly a year -- and yet results are easily beating Wall Street's expectations. True, that bar remains pretty low. But then revenue -- the bogeyman of the prior reporting season -- is coming in ahead of estimates, too. And most important: Guidance is going up.So here we are. The S&P 500 ($INX) looks certain to post quarterly profit growth for the first time in more than two years, with preposterously easy year-over-year comparisons allowing fourth-quarter earnings to more than triple, according to Thomson Reuters. And yet the market, having discounted all this and more, couldn't care less. Apart from when the news is bad, earnings reports have gotten the cold shoulder from investors so far this season.

There's little wonder there, says John Stoltzfus, senior market strategist at Ticonderoga Securities, considering that traders got bombarded with a Rolling Thunder of uncertainty over the last couple of weeks. To recap just a few of the louder ka-booms: China tightened credit, political uncertainty hit Washington and the health insurance reform bill, and the president renewed his populist attack on Wall Street. (The Geithner hearings, the Fed policy statement and Greek debt crisis didn't help matters, either, says Stoltzfus.)

An Acutely Ominious Sign?

"All of this together really pushes earnings out of the spotlight and puts the brakes on what has been a remarkable trajectory from the lows last March," Stoltzfus says. "The market is trying to determine how far have stock and commodity prices gotten ahead of economic growth. Everything that has suddenly happened recently -- and in some cases, suddenly in the world, politically and macroeconomically -- likely pushes the market sideways to lower for a while."

Which is either a waste of a very good earnings season -- or an acutely ominous sign. For the record, of the 220 companies in the S&P 500 that have reported quarterly earnings heading into this week, 78% have beaten the Street, according to Thomson Reuters analyst John Butters. To put that "beat rate" in perspective, on average 61% of companies exceed analysts' expectation in any given quarter. Meanwhile, if that 78% figure holds up, it will be the second-best showing since Thomson Reuters started tracking the data in 1994.

More impressive (or disconcerting, considering the market's indifference) is that taken as a whole, companies are reporting earnings that are 17% greater than Street estimates. That's well above the 2% long-term average and a complete pivot from the last eight quarters, during which earnings collectively came up short by a dismal 6%. A 17% "surprise rate," should it hold up, would set a record, also dating back to 1994.

Two-Thirds of Companies Are Beating on Revenue

Yes, it's still true that most better-than-expected bottom lines have been built on costs cuts rather than revenue growth, but top lines are coming in ahead of Street views, too. Thomson Reuters has been tracking sales only for the last few quarters, but they are improving sequentially and sharply, Butters says. Of the S&P 500 companies reporting so far, 67% have beaten on revenue, says Butters, up from 59% in the third quarter and 49% in the second.

Finally, there's corporate earnings guidance, arguably the most important part of any earnings season, since stocks are supposed to be forward-looking. On that score, the percentage of companies raising outlooks versus slashing them stands at six-to-one, according to research from Bespoke Investment Group. That rate will likely come down as the season progresses, Bespoke says, but it's nevertheless very good.

And yet even as the forward earnings picture has improved, the market has become trip-wire attuned to any hint of bad news. Witness how Qualcomm (QCOM), the cyclically hypersensitive chipmaker, manged to crater the tech sector and ultimately the broader market Thursday when it issued a soft forecast. Never mind the larger trend -- when a single data point such as Qualcomm moves the market, investors are more interested in holding on to what the great rally of 2009 bestowed than being greedy for more.

"Simply No Way to Sugarcoat It"

As Tobias Levkovich, chief U.S. equity strategist at Citigroup (C), told clients last week, an underlying sense of risk appears to be building. "After enduring the pain of severe stock market losses from late 2007 into early 2009, plus the bounce back off of last March's lows, it would seem normal for investors to wonder about their willingness to further take on investment risk," Levkovich wrote.

What's perhaps most troubling, if not downright spooky, is that on a technical basis, the market is clearly signaling it has gotten ahead of itself, write the folks at Bespoke. "This type of action, when the market trades sharply down even though economic reports and earnings reports both beat estimates handily, is not good," Bespoke analysts say. "There's simply no way to sugercoat it."

"At any point, something can spark the market back to the upside," say the folks at Bespoke, "but for now, the short-term trend is down." When Wall Street's favorite treat of beat-and-raise reports fails to spark shares prices, you know something ain't right.
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