Earnings Season: Five Things We've Learned So Far

A cursory look at quarterly earnings this month suggests corporate America is regaining its foothold and ready to run again. But a look at the stock market's reaction indicates otherwise.

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

So goes the dichotomy of third-quarter earnings, in which positive surprises have outweighed the negative by about 4 to 1 though stock gains have been muted.

In fact, since the Dow crossed 10,000 on Oct. 14, stocks have done almost nothing despite a flurry of beats from some of Wall Street's biggest names.

Investors' reaction, in fact, has been decidedly undecisive to all the seemingly good news.

"The overall market really seems fatigued at this point in the rally," says Gary Flam, portfolio manager at Bel Air Investment Advisors in Los Angeles. "The key question is, is this just a pause because solid earnings were expected and then we take off from here, or has the market petered out and we're due for a pullback?"

That's just one of the issues to consider as these five trends seem clear from the halfway point in a robust earnings season:

1. Things Aren't That Bad

If there's one thing that inspires near-unanimous agreement in the market, it's that the worst is over, especially compared to the horrid state in which Wall Street found itself a year ago.

That's been reflected in earnings such as Friday's spectacular report from Microsoft as well as other sound beats from market titans such as JPMorgan Chase, 3M and Caterpillar, each in its own way a gauge for how well some of the most beaten-down areas have rebounded since the depths of the financial crisis.

"The move in Microsoft is of the magnitude that we haven't seen in a couple years," Art Hogan, managing director of Jefferies, told CNBC. "This is significant news."

That the market as a whole hasn't done cartwheels over the moves isn't necessarily worrisome to some experts. Perhaps the market has just taken a healthy pause after a more than 50 percent runup in the past seven months, a healthy alternative to a major selloff that earnings disappointment could have engendered.

"I don't think it's a bad thing for the markets to take a breather here," says Tom Higgins, chief economist at Payden & Rygel in Los Angeles. "This is good for the market at this point."

2. Things Aren't That Good, Either

The primary indication most market pros sought from this season was a growth in revenue—the "top line"—rather than merely profit driven by cost cutting to the bottom line. The latter phenomenon was almost solely responsible for powering second-quarter earnings, where upside surprises beat the downside 3 to 1.

They got what they were looking for, but to varying degrees.

In fact, in some cases strong top-line growth wasn't even good enough. Goldman Sachs was the poster child for a firm posting powerful revenue gains that still disappointed because analysts didn't like where the growth came from.

"What we wanted to see going forward is organic earnings growth driven by core businesses," Higgins says. "If you take financials for example, (they gained with) strong trading activity, which is fine in the short run. In the long term you want to see banks increasing lending and have that driving profitability. That's where they should be making their bread and butter, not trading and rising asset prices."

Moreover, while most of the big names topped expectations, the overall picture for the industry was mediocre.

Of 39 banks sampled by Keefe, Bruyette & Woods, 19 banks beat, 19 missed and one hit—hardly numbers indicative of a strong turnaround.

The results, KBW said in a research note, "indicates the great disparity among (quarterly) earnings results."

Stuck in the Middle With You

3. Investors are Stuck in the Middle

One of the primary reasons the markets haven't moved much in the past few weeks is that investors actually were expecting a strong quarter and, with the news now passed, will need more convincing to keep up the breakneck buying pace.

"We're at equilibrium here based on corporate profits, earnings and expectations," says Michael Cohn, chief investment strategist at Atlantis Asset Management in New York. "The market tells you what's going to happen in the future, and when expectations are fulfilled it sells on the news.

"There's not really all that much to look ahead to. The market made its prediction, the prediction's coming true, now the jury is out for the next quarter."

And there could be a bit of disappointment out there that earnings didn't post even stronger beats on analyst estimates—part of the "whisper-number" factor in which traders often decide on their own what the real earnings number should be.

"It leads me to believe there's a certain amount of financial engineering going on within authorized generally accepted accounting principles, but nonetheless earnings appear to be surprisingly good," says Emily Sanders, president of Sanders Financial Management in Atlanta. "The magnitude of earnings beats speak to the fact that we're against very low expectations, but still our view of the economy is that it really has not turned around yet and is still less worse than it was a year ago."

4. Will the Patient Stand on its Own?

Investors often pay as close or closer attention to earnings outlook than the actual numbers themselves. But forecasts are even more important this year as the government prepares to lower the curtain on economic stimulus measures.

"The economy will have to stand on its own two feet more than it has up to this point," Sanders says. "We have been awash in a lot of liquidity, but the downside of all that is starting to be foremost in people's minds."

While the market engages in a lively debate over whether inflation or deflation poses a greater threat, there is consensus that the Federal Reserve and Treasury will have to be skillful in how they deploy their respective exit strategies.

Bel Air's Flam compares the mission to that of Capt. Chesley "Sulley" Sullenberg's daring landing of a passenger jet in the Hudson River on Jan. 9.

Fed Chairman Ben Bernanke and Treasury Secretary Timothy Geithner will have to "pull a Sulley," Flam says. "You've got to land the economy on the Hudson here. You pull back too quickly and you can kill any budding growth, and if you do it too slow you can spur inflation. They have to touch down just right."

5. Sitting Tight

Market analysts continue to worry about a lack of market conviction, and reticent investors are likely to continue to be the norm.

Equity fund inflows actually increased last week to $6.55 billion—the biggest number since May—but many advisors are telling their clients to tread carefully.

"We're playing it defensive," Sanders says, adding that her firm is doing a lot of short-term trading and sticking with dividend-paying stocks. "Short-term there's a lot of competing interests to resolve some of the big, open issues like financial regulation, health care—the market doesn't like uncertainty."

For Cohn, this is setting up as a good time to collect some profits until the market shows it's ready for another leg up.

"I would take a few chips off the table here," he says. "No one ever lost taking a small profit."