In a recession as long and as treacherous as the one we have been in for the last 19 months, each earnings season carries with it a lot of expectations and hopes. Earnings season for the second quarter of 2009 was seen by many as a critical impasse where we would find out which direction the economy was moving. The first quarter had been correctly characterized by companies beating earnings estimates because those estimates had dropped off a great deal. The results were not particularly good but they were better than expected and the market rallied strongly, as we saw the market rise for about ten straight weeks. The broad market’s strength after the first quarter earnings were released was extraordinary, and put additional pressure on the next round of earnings.
We are still fairly early in the second quarter earnings season, but many of the biggest companies have reported and a clear trend has begun to develop again this quarter. A significant majority of companies are beating estimates again, according to data compiled by Bespoke Investment Group as of 7/21/2009 nearly 72% of companies are beating the consensus estimates. That means that 137 of the 191 stocks that have reported thus far have beaten the Street’s view by one degree or another. Some of the better surprises came from stocks like Goldman Sachs (NYSE:GS), International Business Machines (NYSE:IBM), Caterpillar (NYSE:CAT) and even Starbucks (NASDAQ:SBUX).
In response to these earnings beats as well as more signs of stabilization in macroeconomic indicators, the S&P 500 has jumped 8.5% in just the last 9 trading sessions and the Nasdaq is riding 10 straight days of advances. The question that investors have to ask themselves is, does this represent a real improvement in corporation’s business fundamentals or is this simply a case of the analysts being too bearish for the second quarter in a row?
In the first quarter, earnings and revenue were expected by analysts to be just wretched, and companies performed slightly better than that. From our point of view, the second quarter earnings results have been characterized by disappointing revenue results, but aggressive cost cutting has ruled the day and saved earnings results. The results have been better than we expected as well, but it seems that the this rally has more to do with analysts being overly bearish than most stocks reporting impressive earnings.
On a year over year basis, earnings for the S&P 500 are still down 64% based on our calculations. Furthermore, earnings are down 74% from the peak earnings levels achieved in the summer of 2007. Cost cutting is a very reasonable thing for companies to undertake right now, but we would prefer to see more companies with top line growth than we are seeing. That will help us to understand that the grip of the recession is easing and would allow companies to afford responsibly and reasonably grow costs (such as employment) that will allow them to aggressively pursue growth.