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The Effects of Earnings Season.

Byline: Tom Nawrocki

First quarter earnings season for American corporations was much stronger than expected, with more than two thirds of all companies beating Wall Street's forecasts. This followed on the heels of reports that this earnings quarter was going to be a major disappointment: CNN polled a group of economists in April and found that they expected a 0.1 percent increase in earnings for the S&P 500. Everyone expected Apple to have a strong first quarter, but the consensus for the other 499 companies was that earnings would actually drop, by 1.6 percent.

In reality, first-quarter earnings growth averaged over 7 percent. Of the 30 stocks in the Dow Jones industrial average, 26 of them beat expectations, and another two matched them. Even Hewlett-Packard, which took the occasion of its earnings report to also announce that it was laying off 27,000 of its employees, beat the Wall Street forecasts.

And yet, the market has been sliding sideways lately, if not worse. And the longer earnings season goes on, the worse the market has been doing. What's going on here?

To be sure, it was a very positive earnings season. Companies are expected to beat their earnings forecasts; historically, more than 60 percent of all reporting companies outperform the estimates of the Wall Street analysts. But according to the financial research firm S&P Capital IQ, that number was closer to 70 percent for the first quarter of 2012.

Alcoa kicked off earnings season, as it traditionally does, back on April 10, and like most of the companies that followed, it blew past expectations. While analysts had forecast a small loss, Alcoa announced earnings of 9 cents per share.

Perhaps most impressive was the performance of the financial sector, which saw its earnings rise 15 percent from the previous quarter. Regions Financial Corporation, a multifaceted banking company based in Birmingham, Alabama, saw its earnings per share rise by an astonishing 1300 percent. Even a regional behemoth like Fifth Third Bancorp had an increase in earnings of 260 percent.

But amid all that good news from the individual companies came a string of bad news for the market as a whole. The kickoff of earnings season on April 10 also marked the onset of a larger downturn for the markets. Since that date, the Dow has slipped by more than 2 percent, and the S&P 500 is down more than 3 percent. The S&P's peak for the year came on April 2, just before the earnings-reporting period started.

Why did the market react so unfavorably to what should have been a string of good news? There are several factors at work here:

* Apple's earnings report was so overpowering that it had a disproportionate effect on the entire market. Apple reported earnings of more than $11 billion, well ahead of analyst expectations. As of the beginning of May, the entire tech sector had reported earnings growth of 11 percent. But if you subtract out Apple from the overall results, earnings for the tech sector dropped by 2 percent. Without Apple, earnings growth for the entire S&P 500 would drop from 7 percent to 5 percent.

* Macroeconomic factors stayed depressed throughout the period. At the beginning of May, the Bureau of Labor Statistics released an employment report showing that just 115,000 jobs had been created in April, down from an average of 252,000 new jobs that had been added from December through March. Other government figures released have been similarly disappointing.

* The European situation got worse, if anything. A dozen European nations, including Spain and the United Kingdom, have slid back into recession, and the Greek debt crisis has still not found a resolution. Many investors fear that the European recession will soon find its way back across the ocean.

* Investors have gotten too savvy; they now expect everyone to beat their earnings estimates. During the current earnings season, Alliance-Bernstein Investments quantified the effects of this. The company's research found that S&P 500 companies that beat their estimates outperformed the overall S&P 500 by just 0.9 percent on the three days surrounding the day of the earnings report. On the other hand, companies that fell short suffered a much bigger penalty. Those stocks that missed their earnings estimates ended up lagging the index by 4.1 percent on the days around their earnings reports.

So there's hardly any benefit for beating an earnings estimate, but a substantial penalty for falling short. In a way, that's a good thing, in that investors are reacting more to long-term trends than they are to quarterly results. Perhaps we've reached the stage where earnings season no longer carries the significance it once had.

For more from Tom Nawrocki, see: Apple's Ups and Downs Trends in Expense Ratios Hybrid Funds Are on Fire
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Publication:National Underwriter Life & Health Breaking News
Date:May 31, 2012
Words:807
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