Jubak's Journal
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• Tear up the earnings rule book, 4/29/2003
• Lies, damned lies and earnings reports, 4/25/2003
• Can earnings disappointment ever be good? Yes, 4/18/2003
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Can a rally built on hope last?
Over the last month, the major stock indexes have climbed smartly. Some point to strong first-quarter earnings as the reason, but it'll be tough for companies to repeat that performance.
By Jim Jubak
To understand this rally, you have to take apart the strong corporate profits reported so far this earnings season. For example, take a look at the financial sector.
The stocks of financial companies that have reported strong results have been flying in the last month. Capital One (COF, news, msgs), up 33% in the last month, reported earnings per share 63% ahead of those for 2002's first quarter. J.P. Morgan Chase (JPM, news, msgs), up 23% in the last month, reported earnings 21% ahead of the year-earlier period. ABN AMRO (ABN, news, msgs), up 17%, in the month, reported earnings 74% above last year's.
You get the idea.
Those reports are part of a pattern that, according to Thomson First Call, would put first-quarter earnings for the stocks in the S&P 500 about 13% higher than in the year-ago period.
But the shares of financial companies reporting lousy results have been soaring, too. Bank of New York (BK, news, msgs) said first-quarter earnings fell 11%. The stock is up 29% in the last month. Charles Schwab's (SCH, news, msgs) earnings fell 38%, but the stock is up 22%. Northern Trust (NTRS, news, msgs) reported a 25% decline in earnings. Its stock is up 15%.
The key questions
So what gives? Why have earnings underperformers been recording gains equal to those whose earnings outperformed? It's because the first-quarter earnings are in many cases essentially meaningless. The quality of earnings in the most-recent quarter is so low that the reports dont tell investors a thing about how companies will perform for the rest of the year.
There are four reasons earnings this time around tell so little about the future
First, they're inflated by profits from trends that are winding down. At ABN AMRO, companywide revenues were up just 0.6%, but revenues from the United States came in 17% above projections. Why? Thank the continued strength of the mortgage refinancing boom in the United States.
Second, theyre inflated by good luck thats tough to repeat. Merrill Lynch (MER, news, msgs) almost doubled its revenue from trading bonds from the fourth quarter to the first quarter.
Third, theyre inflated by cost-cutting that will have to be reversed when the economy picks up. Eight cents per share of earnings at Capital One came from cuts in marketing expenses, yet the number of credit-card holders dropped by 1 million.
Fourth, theyre inflated by a weak dollar and a strong euro. Any company with earnings from Europe got a 22% boost in the first quarter when those strong euros were exchanged into weaker dollars in the financial report.
Bid 'em up
Even with first-quarter earnings such bad guides to trends for the rest of the year, investors have been bidding up the stock of pretty much any company thats likely to benefit if hopes for the second half of 2003 come true. So Charles Schwab is up, despite lousy earnings this quarter, because investors believe that individual investors will return to the financial markets in the year's second half. And Bank of New York is up because investors believe trading volume will pick up.
They could be right. Wall Street analysts are projecting 12% earnings growth for the third quarter and 22% for the fourth quarter. And thats what makes this rally so tough to handicap. What will it take to confirm those hopes or dash them?
Not second-quarter earnings. With earnings growth projected to drop to 6% or less this quarter, investors have already written off those results.
Big-picture economic numbers arent likely to provide near-term help, either. Economists wont have a good read on how the economy is doing without the effects of the war in Iraq until they get data in June or July.
So while in the absence of solid numbers this rally is built on hope, the delay in getting those numbers means it could run for a while.
Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. The Wednesday edition stems from Jim's appearance on CNBCs Business Center most Wednesday nights at approximately 5:45 p.m. ET. Selected CNBC stories can be found in the TV Reports index.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Charles Schwab. He does not own short positions in any stock mentioned in this column.
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