It is hard to believe, but it’s that time of year again.  The earnings parade commences in earnest this week, with heavyweights Google and Goldman Sachs both set to report on Thursday. 

As we have said before, we believe that earnings reports will be particularly crucial both this quarter and next.  It is true that a great deal of earnings surprises over the summer months came predominantly from the cost side of the equation.  Now, six months after the market lows, we should begin to see some faint signs of revenue improvements as well.  If so, the earnings gains may be even more leveraged as margins expand.

We continue to believe that the economy is in recovery mode and that a focus on the more cyclical sectors of the economy will likely generate the greatest relative gains for portfolios over the next six to twelve months.  The Fed will likely remain on hold, but be biased towards tightening at the first signs of improving unemployment.

What could lead to an improvement in the unemployment rate?  Aside from time, increased production levels and continued, strong free cash flow generation should give companies the confidence to start hiring again.  We suspect that this phenomenon will become more evident by the spring of 2010.

Aside from these macro comments, a couple of other items caught our eye this morning.  First of all, Meredith Whitney downgraded Goldman Sachs to neutral from buy.  She has been very good with her calls and it will be interesting to see how the call ends up looking when Goldman reports on Thursday.  Second, TIPS (Treasury Inflation Protected Securities) have gained 8% this year while Treasuries themselves have declined 3%. This divergence in performance is one of the largest on record.  Bond powerhouses PIMCO, BlackRock and Vanguard have been big buyers of TIPS lately, suggesting that “smart money” is positioning for resurging inflation.

Finally, I have been watching the prices of many bank stocks in recent weeks.  This morning, I was amazed to see that the stocks of several higher quality banks like JP Morgan and Wells Fargo are only 10% or so off their all time highs.  Really?  Perhaps that is what a government guarantee can do for you.  But perhaps I ought not to be so quick.  There also appears to be a group of lower quality bank stocks like Bank of America that remain 50% off their highs.  

With a great deal of our quarter end activities now behind us, we hope to be blogging more regularly.  If you have thoughts or ideas that you’d like us to discuss, please throw them our way.