Earnings season is upon us.  It is always one of the more stressful periods of time in the business.  Not because we don’t have a good feel for how our companies are likely to do, but because we don’t know what the stock market’s response to such news will likely be. 

There seems to be two categories of companies so far this earnings season.  Those that miss earnings, reduce guidance and cut dividends and those that meet or beat expectations but provide a more tempered outlook about the future.  In the former category, many stocks have rallied significantly on tough news, perhaps because things got so bad and the enforcement of new short sale rules provides a nice reprieve.  In the latter case, the stocks have often been met with swift ten percent haircuts in spite of showing considerable year over year growth in a very difficult environment.  In general, the lowered guidance has often been a function of ramping expenses ahead of new product cycles, something that would be welcomed in more normal market environments.  

Summing it up so far, junk has been rallying and quality has been selling off.  In our experience, the overall tone of the markets has a bigger impact on what stocks will do in any given quarter in response to the earnings treadmill.  When companies say something, they can’t say everything and are themselves in many cases making educated guesses.  In bear market environments, the emphasis rests on what is not known — the uncertainties — rather than what is known.   In bull market environments, uncertainties are typically an afterthought and are hardly worthy of conversation. 

Earnings season is always interesting as it is a good way to pick up additional information on how the current economic environment may be impacting specific company’s results.   It can also, however, be counterproductive if investors extrapolate a given quarter’s earnings into a flow of earnings over time.  In this sense, the earnings treadmill may be a necessary evil.

For what it’s worth, we’d stick with quality and focus on those companies and industries that are less tied to the ebb and flow of the economic cycle.