Earnings preview for a bull market; what to expect for 1Q14

April 4, 2014
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bull1Q14 earnings will begin in earnest by mid-April with the market flirting with new highs over the past several sessions. Geopolitical concerns, and Fed taper fears, are gradually fading into the background, and investors are in for a period of individual earnings results driving stocks, and ultimately, market performance. The setup for 1Q is unique; the weather was abysmal this quarter, depressing spring seasonal business activity. The issue of poor weather is well known, particularly for those living in the northern half of the US, so expect the market to look through depressed results. In a sweeping bull market (a good characterization of today’s market) investors tend to provide the benefit of the doubt, looking for excuses to stick with, and build positions. The focus turns towards “what could be” as opposed to “what could go wrong”.

Market technicals coupled with a degree of under-investment is driving the market higher. Eventually, the potential exists to move into frothy territory, but at current valuation multiples, we aren’t there yet. Periods of market lull, or minor 3-5% drawdowns, are healthy events going forward, and allow for valuations to improve. CJF prefers to be adding to positions after lulls/drawdowns as opposed to pressing exposure on breakouts to new highs. This said, it is sensible to stick with most positions during surges, except those driven by unsustainable valuation increases (as opposed to real growth in earnings and cash flows). Items to focus on:

  • The S&P 500 multiple is 15.7x on next 12-months earnings. Over the past 7-months, the market multiple has stabilized in the 15-16x range. This is a fair multiple for a relatively stable, if not booming, economy, and a period of low inflation/interest rates.
  • Note the market multiple drifted lower in 2011, down to 12x earnings – providing the fantastic setup for superb returns in 2012 and 2013 (+16% in 2012, +32% in 2013).
  • In the absence of a clear cut opportunity for the markets’ valuation to move higher, earnings performance becomes critical. Differentiation in results, earnings growth, cash flow growth, and dividend growth drive stock prices. This is what many commentators describe as a “stock pickers market”.
  • Since abnormal weather may depress 1Q results, cadence of business activity becomes as important as actual results. Particularly for companies that “miss” estimates, a saving grace will be acknowledgement that business trends picked up in April.
  • It’s early in the year to address full-year 2014 guidance but be on the lookout for information content from companies that need to guide full-year results lower or have the confidence to increase full-year guidance.
  • The wealth effect driver should be an increasingly relevant theme in 2014, driving earnings performance. With the stock market and housing market coming off banner years (in tandem), businesses exposed to higher-end demand are set to outperform.
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