Solid Earnings Aren't Good Enough for Fickle Investors

Corporate earnings may be hot, but Wall Street is not.

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

As a solid majority of companies have beaten expectations, stocks have responded in muted fashion with major averages dropping below the breakeven point for the year and some analysts talking again of the long-awaited market correction.

Even Tuesday's market gains were seen more a function of an unexpected rise in consumer sentiment, as companies reporting earnings had mixed results in their stock prices.

So what's not to like about companies surprising to the upside by a nearly 4-to-1 ratio?

"Expectations have been rising for the market overall," says Gary Flam, portfolio manager for Bel Air Investment Advisors in Los Angeles. "It seems like over the last month the definition of risk changed from losing money to missing the next move higher. You saw a shift from fear to greed. All the news of the last week did was highlight there is still uncertainty out there."

But the news to which Flam refers is not the news from earnings but rather other events that overshadowed the earnings reports.

China said it was tightening lending restrictions; President Obama announced a move to clamp down on big banks; a Republican shocked Washington by winning the Massachusetts Senate seat held for 40 years by liberal lion Edward "Ted" Kennedy."

With all that noise in the market, it was tough for any earnings optimism to seep through.

"The 800-pound gorilla in the room...was Brown being elected to the Senate, which means it is highly likely we will have nothing going on," says Dirk Van Dijk, chief strategist at Zack's Equity Research. "Is the market now saying we might not like everything that Obama is proposing but we need to do something?"

The Dow industrials are off more than 4 percent since the latest vicious news cycle began last Wednesday, despite solid earnings beats from companies such as Apple , Goldman Sachs and McDonald's.

Investors, though, have been less impressed, due in part to further disappointment by the way some of the companies reporting recently have failed to beat the vaunted "whisper number" that circulates on Wall Street outside of analyst projections.

"As the earnings expectations data have become democratized, where just about any investors has access to them, then the whisper number starts becoming a much more important part of things," Van Dijk says. "I have questions about the ethics of that but it's not for me to decide. People were expecting better."

Political uncertainty also has come into play.

Outside the Massachusetts election, some investors also have been rattled by the uncertainty over Federal Reserve Chairman Ben Bernanke.

Where just weeks ago Bernanke's reappointment seemed like a fait accompli, the probability has been reduced to merely probable rather than certain.

The removal of Bernanke, as well as some of the stimulus programs he has helped initiate, has helped rattle the markets.

"There's a lot of concern if and when the federal government stimulus goes away that the market may not be able support these price levels," says Beth Larson, principal at Evermay Wealth Management in Washington, D.C. "The fact that Ben Bernanke's nomination is even questioned has really thrown the market for a loop. The concern is that we may get somebody in there who doesn't have the experience of the last year and a half with what's happened in these markets."

At the same time, the economy remains a broader issue, with investors rattled also by the news out of China and demanding stronger indications that the US recovery remains on track.

They're looking to earnings reports, then, for confirmation that domestic businesses remain healthy despite any possible hiccups in the world markets.

"The market is looking for a sign of true pick-up in business, which would be reflected in top- line and not the bottom line of cost-cutting and keeping people laid off," says Tom Samuels, portfolio manager at the Palantir Fund .

Despite the inability of earnings to give the market a boost, there remains a high level of hope that the market will be fine in the long run.

Samuels says infrastructure-related industries will do well as the government focuses on job-creation, while Larson says technology and health care are likely to be growth areas this year.

Investors need to be cautious about how they view the impact of earnings, Larson says, but otherwise have reason to be optimistic about stocks.

She predicted a period where the market levels may have to catch up to price-to-earnings ratios, but otherwise represent a solid value.

"If you have new money to invest, the market is down a little bit year-to-date and this may be a good time to start an investing program," Larson says. "You don't want to get spooked by what's going on in the markets. In the long run the equity markets are heading up."