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If Stocks Drift During Earnings, How Can You Make Money?

With stocks coming off a robust end-of-year rally and likely to get little or no boost from strong fourth-quarter earnings, investors may have to get used to a fairly dull market for a while.

A trader at the New York Stock Exchange.
Photo: Oliver Quillia for CNBC.com
A trader at the New York Stock Exchange.

How one makes money in such a climate isn't easy, especially with the major averages showing signs of churning in a fairly tight range.

For the near term, though, the strategy likely will be to try to find entry points into a market that appears overbought but is also likely to trend higher even if the quarterly earnings seasoncreates a sluggish environment.

"It wouldn't be a surprise to see good earnings and more muted returns, especially given the results we've seen" in the stock market, says Gary Flam, portfolio manager at Bel Air Investment Advisors in Los Angeles. "Buy-the-dip mentality has returned to stock investors and that will continue to be the best strategy for at least the first half of 2011."

That strategy, though, could take on as much of a stock-by-stock and sector-by-sector approach as it does a broad market move.

Investors have been less enthusiastic about companies that meet earnings numbers through cost-cutting and more interested in those that have met bottom-line goals and raised revenues—profits through production, rather than cost-cutting.

"[W]here normally companies with positive earnings surprises generally outperform, during the last several quarters the only segment to consistently outperform post-earnings announcements were stocks that surprised on both top and bottom line estimates," Savita Subramanian, quantitative strategist at Bank of America Merrill Lynch, wrote in a research note for clients.

Using guidance and earnings and sales revisions as the guide, Subramanian projects consumer discretionary and technology as the most likely sectors to deliver, while consumer staples and utilities could disappoint.

For those looking at the averages, the risky business of timing the market also could become popular.

Flare-ups over European sovereign debt, for instance, have pushed the averages down intermittently over the past nine months or so but have led to interventions from policy makers and, ultimately, recovery in the markets.

"It depends on how cute you want to be," says Uri Landesman, president of Platinum Partners hedge fund in New York. "Its still an up year. If you're going to make real money this year, you're either going to need to trade the market or be uncorrelated with the market."

The latter reference is to finding asset classes or sectors that do not traditionally move in tandem with the broader market and use them as hedge tools.

From a technical standpoint, Landesman's near-term view is that the Standard & Poor's 500 has until Tuesday to break through 1,300 or it could break down to 1,230, which would represent the low end of an intermediate range. More broadly, he thinks the S&P is likely to trade the year in a wide range between 1,100 and 1,400 and end at 1,375, around the low end of consensus expectations.

Many on trading floors have been waiting for a good correction to take hold so they can find a way back in a market that most strategists expect to have a 10 to 20 percent upside this year.

"We're way overdue for a correction," says Dave Rovelli, managing director of US equity trading for Canaccord Adams. Should a pullback set in, Rovelli sees banks as the best buying opportunity.

"Financials are going to lead the market higher," he says. "They have the highest earnings potential. That's where people think they're going to make the biggest scores."

Indeed, JPMorgan Chase was the main engine behind the market's modest rally Friday. The financial titan beat its numbers on both the top and bottom lines, with earnings of $1.12 a share and revenue of $4.8 billion for the quarter.

Financials were easily the market's best-performing sector Friday, giving rise to the notion that finding pockets of strength likely will be the best strategy through the season, while looking for the broader market to outperform will be difficult.

"It is reasonably like that the market is going to trade down and correct a little bit unless these earnings are surprisingly good," Landesman says. "The bar for exceeding expectations is higher than it was. The odds are, the tougher the hurdle the less likely you are to clear it."