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Great Expectations

As we got back into the swing of things again last Monday, we were trying to evaluate what we should do differently. We stuck to our guns for the most part – generally beta-neutral with a large portion of a returns generated from stock-specific risks. This strategy has been working out fine for us. I, however, also ventured into the dangerous territory of catching the big earnings surprises this season. I must admit I’ve done an astonishingly horrible job of picking “earnings surprise winners”. I was reminded that it is yet another skill I will never possess. I was also reminded that it is one thing to pick the companies that are likely to surprise, but it’s quite another to gauge how markets will react to these surprises. Some reactions just don’t make sense – case in point, BroadSoft on 11/07/2012.

I was somewhat perplexed by my dismal performance, and in trying to make sense of it I looked for two data points. Firstly, where are composite index earnings relative to historical levels? Secondly, how many companies have beaten expectations? Using the S&P 500 Index as a proxy, the numbers make me look even worse. The S&P 500 Index Adjusted EPS is at its highest point in 5 years. Since the competition restarted, about 70% of the companies that have reported have beaten expectations. However, something still didn’t quite make sense. Since the competition restarted, the index is down -1.8%. Is this a case of even greater expectations or is it simply that the Greek Drama is taking its toll on peoples’ sentiments? If it’s the latter, will the show be over so that the market catches up to the record profits reported? Will it happen before the MBA Face-Off ends on November 25th? Market timers – this may be an opportunity for you. As far as we are concerned, we will continue to stay away from the timing game. I, for one, will certainly resign from the business of gauging expectations, especially when they are so great.

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