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Tuesday Look Ahead: Positive Earnings Could Thwart Some of 'Sell in May' Effect

Positive earnings surprises have helped keep stocks buoyant, a trend that may help counteract the "sell in May" theory.

NYSE Trader
Photo: Oliver Quillia for CNBC.com
NYSE Trader

Tuesday's calendar contains a flood of corporate profit reports from a variety of companies, including Coca-Cola , Ford , MMM , UPS , Lockheed Martin , Valero , Illinois Toolworks , Hershey Foods, Arch Coal and U.S. Airways .

Amazon.com reports after the closing bell, along with Broadcom , Altera, Becton Dickinson, Hertz, Stanley Black and Decker, DeVry, Panera Bread and Western Union .

High-flier Netflix was hit hard after Monday's closing bell and was down more than 5 percent as a disappointing forecast offset a better-then-expected profit report. Of the first 150 S&P 500 companies that reported this quarter, 75 percent of the earnings were better than expected, according to Thomson Reuters.

Stocks Monday dipped slightly in quiet trading. The Dow was down 26 at 12,479, and the S&P 500 fell 2 to 1335. The big excitement was in the metals market, where gold hit a record high and spot silver broke a level just under $50, last seen when the Hunt brothers tried to corner the market 30 years ago.

The dollar continued under pressure Monday, and was a focal point as investors look ahead to the Fed's two-day meeting, which starts Tuesday and ends Wednesday with a 12:30 p.m. statement. There is also a first ever media briefing at 2:15 p.m. from Fed Chairman Ben Bernanke, and the market has been buzzing about what the Fed chairman is likely to discuss.

For one, the Fed is expected to signal the end of quantitative easing, the program under which the Fed is purchasing $600 billion in Treasury securities. The Fed, however, may retain a program under which it is buying Treasurys with the proceeds of its mortgage holdings, as they roll off, and it may do the same with its Treasury holdings. That would give the Fed a potential $40 billion in month of Treasury purchases, according to some analysts' estimates.

The dollar Monday lost 0.2 percent against the euro, which was at 1.4583. The euro has gained almost 13 percent from its 2011 low of 1.291 and 9 percent from its 52 week low.

There has been talk that Asian central banks are intervening by buying dollars to stem the rise in their currencies, and are then swapping some of those dollars for euros, which has helped the euro's run, said Win Thin, senior currency strategist at Brown brothers Harriman.

"There's really nothing going on. It's really quiet. The FOMC later in the week is the event risk. Everyone's short dollars going into this.. If there was a hawkish surprise, you could get a short term bid on the dollar," he said.

What to Watch

Tuesday's data includes the S&P/Case-Shiller home price index at 9 a.m., and consumer confidence is at 10 a.m. The Treasury auctions $35 billion in 2-year notes at 1 p.m.

As stocks headed slightly lower Monday, the day's laggards were the favorite energy and materials sectors, both off more than a half percent. Morgan Stanley strategists Monday cut their overweight in energy stocks to market weight. They also turned negative on consumer discretionary stocks. The analysts said both energy stocks and oil have risen sharply, and the risk-reward of the oil price "seems modestly skewed to the downside."

They also noted that energy company earnings estimates have increased and profit margin expectations have become lofty, as the price-to-book multiple has jumped to where the sector now trades at 2.4 times book, up from 1.5 times last fall.

"Higher oil prices appear more digested into oil equities in a positive way than they are negatively discounted in consumer discretionary stocks. We recommend an underweight in consumer discretionary stocks and believe the impact on consumer companies' P&Ls will be strongest in 2H, 2011," they noted.

Oil prices Monday settled at $112.28 per barrel, down a penny on the NYMEX.

Don't Sell in May

Standard and Poor's analyst Samuel Stovall has been analyzing the impact of the better earnings reports on S&P estimates, and he also says the sell off in February and March may have made the potential for a market decline less likely now. He also said instead of following the old adage, "sell in May and go away," investors should rotate the sectors they hold to more defensive areas.

"I think since we had the pull back from Feb. 22 to March 16, I think that sort of delays when we might experience a sell off or consolidating patterns...I think also because corporate earnings are coming in better-than-expected that too could delay it and also just based on where we are in the presidential cycle," he said.

"I happen to think the market's going to work its way higher. May is not a bad month. The average is a gain of 0.3 percent, versus the 0.6 percent for the average month, and while the return is less in May, than other months, the volatility is also less," he said.

In a note Monday, he pointed out that the defensive health care and consumer staples sectors are the ones that typically outperform in May through October, with gains of 5 percent and 4.8 percent respectively. During that time, the S&P 500 averages a gain of just under 1.5 percent.

The consumer discretionary, financials, tech and materials do better in November through April historically.

As far as the quarter's earnings, companies are doing 2.6 percent better than expected by Wall Street analysts, said Stovall. "Actually, I thought the bar was set pretty high because there were not a lot of preannouncement disappointments," he said.

According to data from S&P's Capital IQ, financials are one of the three weakest sectors in the first quarter, and telecoms and utilities are actually being adjusted lower than their estimates, as of March 31. (see charts below). "The standouts are materials," he said. Materials companies earnings for the first quarter are now expected to be up 7.5 percent from analysts' March 31 estimates. Health care and energy first quarter earnings have been revised up 3.5 percent, and industrials are up 4.1 percent. Tech earnings have been revised up 5.3 percent. The numbers include actual results from companies that have reported, and estimates from those that are yet to report.

As of last Thursday, analysts had raised their first quarter forecasts for the earnings per share of the S&P 500 to $22.77 per share, compared to $22.20 expected by analysts on March 31. For the year, they now are forecasting $98.72, up from $97.60 expected on March 31.

Stovall said the S&P 500 since 1945, has seen a gain of 0.9 percent on average in May through September, but a 1.3 percent gain from May through October. The November through April period has seen the market 6.8 percent higher on average but the average in the October through April period is 7.percent.

Stovall said he expects the S&P to finish the year at 1400, and he notes in the third year of a presidential term, the party in power often does things that are market positive while trying to get reelected.

"I think we will see a digestion of gains between now and (year end). I think we're going to hit 1400 and we're going to test some gains and then climb back up to 1400 by the end of the year," he said.

Questions? Comments? Email us at marketinsider@cnbc.com

  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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  • JeeYeon Park is a writer for CNBC.com. Follow her on Twitter: @JeeYeonParkCNBC

  • Rick Santelli joined CNBC Business News as an on-air editor in 1999, reporting live from the floor of the Chicago Board of Trade.

  • Senior Producer at CNBC's Breaking News Desk.