Good Earnings Don’t Help the Market

About of half of S&P 500 companies reported Q4 results, and so far, these results are very similar to those of previous few quarters.  Not only most of the companies are beating estimates, the guidance going forward is also generally exceeding analysts’ expectations.  That had been the case with a number of bellwether companies, such as Intel, Apple, Goldman Sachs, etc.  The economic news have also been fairly positive.  While there were some disappointments in recent employment and housing data, manufacturing and consumer confidence are on the rise.  During the fourth quarter of 2009, U.S. economy grew at 5.7% rate, much higher than expected.

Nevertheless, the markets reacted in decidedly negative fashion to these benign reports and good earnings.  We saw a drop of about 8% from the 15 month market high reached just two weeks ago.  Skeptics are ready to point out that such a negative reaction to positive developments indicates that good news are already reflected in stock prices and that more trouble lies ahead.  Indeed, back in March 2009 the news were overwhelmingly negative, and yet that marked the beginning of the rapid market rise.  On the other hand, a correction such as we are experiencing is normal and is to be expected on a regular basis and especially after a huge rally we had last year.  In fact, since March 2009 there were three corrections already of the similar magnitude and the market kept marching higher after each one.

Who is right this time?  You know that no one can possibly answer this question.  In my view, we have reached a point where easy money has already been made on the way down and on the way up.  Any “dartboard portfolio” lost money in 2008 and made money in 2009.  I think that at present, stocks are reasonably valued and the skill of stock selection will once again become important going forward.

There are some global developments that definitely merit watching.  Financial crisis in Dubai, downgrade of Japanese bonds rating, and high debt obligations of Greece are troubling.  You are probably familiar with the acronym BRIC, which refers to fast-growing developing economies of Brazil, Russia, India and China.  Now we have another acronym: PIIGS.  This one stands for Portugal, Italy, Ireland, Greece, and Spain — countries in European Union that have high debt loads and face a possibility of default that would strain the whole Euro zone.  I even heard views that the euro as a currency may cease to exist within the next five years.  If indeed any of the PIIGS of the world comes even close to a default, you can be quite sure that this will not do wonders for any of the world stock markets.

We do have a lot of uncertainty at this point but this is nothing new.  In my view, a sensible investor must keep a well diversified portfolio of high quality stocks and be always positioned to take advantage of positive market moves.  This has worked extremely well for me last year.  In addition to that, caution and certain downside protection would also be warranted.