Friday, July 24, 2009

Rally Resumes on Positive Earnings Surprises

The S&P 500 Index has rallied an impressive +11% in just the past two weeks, after declining by -7% from early June through early July. The catalyst behind the resumption of the rally that began in March seems to be some underlying good news in another otherwise dismal earnings season.

According to Bloomberg, through yesterday, 181 (about 36%) of the companies in the S&P 500 Index had reported second quarter earnings. The results aren’t pretty, as earnings have fallen by -26% from the second quarter of 2008 thus far. But, encouragingly, there have been 136 positive surprises (meaning that earnings came in higher than forecast) versus only 43 negative surprises. Even better, as shown on the chart below, 9 out of 10 sectors have more positive than negative surprises (Technology is the lone exception, and there it is just about even – 14 positives to 15 negatives), implying that the phenomenon is broad based. Apparently investors have interpreted this as an indication that analysts have grown too bearish, and they’ve responded to the possibility of better earnings going forward by buying stocks.

An improved earnings outlook for corporate America, along with signs of stabilization in economic data, provides more evidence that the dark clouds hanging over the economy are gradually being driven out to sea.