As promised earlier, I am updating and posting my latest model graph from 4/22/2016. Earnings jumped substantially last week and that was surprising given the generally slow economy. However, when one quarter is over then analysts can add on a quarter to their estimates for one year out. It is, of course, possible that earnings estimates will be reduced going forward but it is only speculation at this time. For now, my model is calling for a 30% exposure to equities.
I'm up in the Texas panhandle getting blown away by the spring winds so I don't have a full update right now. However, I've looked at my indicators and see that there was a huge increase in earnings expectations for my adjusted S & P 500 average less commodity companies last week. The percentage of companies expected to report up earnings in the next quarter also increased. Obviously, the market has been in the process of discounting this good news over the past few weeks. On the negative side, valuation has gotten worse and is now rated as neutral-bearish. My model has gone back to a positive outlook but still only a 30% exposure at this point. I'll post a full update in a few days.
Earnings expectations continue to drift lower, yet the market moves higher. The market is usually right so maybe earnings will stabilize here after the first quarter and begin to move higher but I'm not willing to speculate on that outcome so my model continues to call for a zero market exposure. If valuation were better or sentiment indicated panic, I would be inclined to participate but that is certainly not the case right now. The risk/reward ratio looks very unfavorable here and I'm happy to wait this situation out awhile longer. I'm looking at adding a technical factor to my model that would tend to move with the market but even that indicator is just neutral at present.
Earnings expectations continue to decline slowly but it is too early to say for sure if this is merely a pause in growth or something more serious. Given the current world economy, I suspect things are going to get worse. First quarter earnings will begin to be reported this week and it will be important to listen to projections for clues as to the future. My other indicators, valuation and sentiment, are both neutral and there is no reason to expect positive influences from either one. I am maintaining a hedged portfolio and have done relatively well this year because my stock picks have been profitable. This has been a difficult market environment because the average stock continues to perform poorly compared to the major averages.
Market action has been frustrating because investors apparently believe delays in rate increases are more important than slowly eroding earnings. I've made a couple of changes to my model this week in order to deal with this situation. First, I have expanded what I consider to be neutral earnings results to take into account the type of slow decline in expectations we have been seeing recently. While certainly not a positive, drifting expectations can be just neutral as long as things don't really collapse. Secondly, I have expanded the universe of stocks I look at to determine what percentage are expecting up earnings this quarter. That metric is slightly positive. So earnings indicators are now neutral because S & P earnings less commodity companies are modestly negative. Since valuation and sentiment remain neutral this week, my model has gone to a zero exposure level. I am still fully hedged.
Richard Moore, CFA
With my wife in Hawaii