Five Things We've Learned From Earnings Season

In what some feared would be a bloody earnings season, Wall Street so far has not merely survived but has thrived as banks largely lived up to lowered expectations and confidence grew that the worst may be close to passing.

Traders buy and sell crude oil futures contracts at the New York Mercantile Exchange.
Traders buy and sell crude oil futures contracts at the New York Mercantile Exchange.

Major stock indexes have registered gains of about 3 percent and the battered and bloodied financial sector has staged a turnaround thought impossible as mortgage giants Fannie Mae and Freddie Mac looked at one point to be in danger of failing.

But investors plowed through and market pros have taken away some lessons from what could be a pivotal time for stocks.

1) Living With Lowered Expectations

While there have been companies that have come out with robust figures--Pfizer most recently comes to mind--much of the excitement has come in the form of earnings that weren't necessarily good but rather not as bad as expected.

Citigroup was among the leading examples, as the biggest bank in the US reported a stunning $11.7 billion of writedowns related to credit issues and an overall loss of $2.5 billion--news that lifted the spirits of Wall Street because it beat the already lowered bar. The result has been a nearly 20 percent surge in Citi shares that has coincided with a similar run-up in banks stocks overall.

"The overriding theme is the majority of earnings are beating the muted expectations, which is a good sign for the market," says Charles Massimo, head of CJM Fiscal Management. "The turnaround in the market has to start somewhere, and the first place it is going to start is a reversal of psychology. Beating these muted expectations brings a change to the market as a whole."

Massimo says it's unclear whether the optimism regarding earnings will make a long-term swing for the market, but says an influx of hedge fund money into stocks shows confidence is growing.

"Hedge-fund managers and big-money managers are going to book profits when they see an opportunity to go back into the equity market. You're starting to see speculative money flow out of the oil market and back into equities," he says. "They more than anyone else are looking for the right opportunity. They're going to spot it before the average investor."

2) It's the Oil, Stupid

Credit it all to better-than-expected earnings if you like, but there's a pretty straight line to draw between the plunge in oil prices and the surge in the stock market. The oil-stocks inversion is nothing new, and it's become particularly pronounced as Wall Street has digested both lower losses and the long-awaited drop in energy costs.

The two have proved to be a powerful tandem, like a Batman who has found his Robin.

"Having had a significant drop in the oil price at the same time as various earnings have been disclosed has made a huge difference," says Diane de Vries Ashley, managing partner at Zenith Capital Partners in Coral Gables, Fla. "Other circumstances would not be providing this subliminal euphoria we're seeing. Without that kind of move (in oil) you really can't get people to focus on anything but, frankly, their gas tanks."

De Vries Ashley sees this round of earnings more closely reflecting reality, something needed from a market that was riding an untenable wave for too long.

"It's very hard to sit back and say 'I'm only down 57 percent from last year.' Think about that for a second," she says. "Your cup is half-empty and half-full simultaneously. It's really quite an accomplishment with a sleight of hand."

The Consumer Gets Pinched

3) Consumers Go Low-Tech

Large names in technology have been bitten by consumers who have less to spend on big-ticket items for their cell phones, digital cameras and computers.

Blame the the credit crunch and inflationary pressures from $4 a gallon gas and less money available from banks to borrow and finance large purchases.

Companies like Microsoft , Intel and Apple have suffered and predicted lowered profits in their futures.

"When we had the double-bottom in March and April, all the tech companies reported and the earnings were pretty good. Now I think we're seeing the total opposite," says Dave Rovelli, head of US equity trading at Boston-based Canaccord Adams. "The consumer's getting squeezed now."

Rovelli notes a conference call Tuesday with American Express had the credit card leader saying the middle class was suffering especially and had cut back its spending.

The fallout from the consumer getting pinched will be felt across the economy and the stock market, Rovelli warns.

"I think we're going to be in a trading range because even if oil is still coming in you still have inflationary problems with food and energy," he says.

4) Getting Bad News Out

Despite the ups and downs of any earnings season, market volatility has remained low.

The market's main measure of fear, the Chicago Board Options Exchange's Volatility Index , has held in the low 20s after eclipsing 30 during the apex of the Fannie-Freddie scare. That indicates that even with the worst of the news, the market is generally taking things in stride.

One of the reasons may be that Wall Street actually is welcoming the kind of full disclosure it got from Wachovia , which reported Tuesday that it suffered an $8.9 billion net loss in the second quarter.

That's the kind of number that under normal circumstances would have sent the market into a frenzy. Instead, investors pushed the stock up substantially higher.

"They got all the bad news out when they reported ... or what we're hoping is all the bad news," Rovelli says. "People took that as a great sign."

Consequently, investors are sitting tight until things shake out, without showing tangible signs of fear.

"We've got to keep in mind the long term," says Bruce Fenton, president of Atlantic Financial in Norwell, Mass. "A couple weeks does not a great market make."

5) Foreign Exposure Helps

Pfizer, DuPont and McDonald's each sang the same song when reporting earnings Wednesday—that strong foreign sales were helping boost earnings.

They joined a growing chorus of firms running the gamut in industries that have used robust demand overseas to offset changing consumer habits in the US. It's a trend expected to have a long shelf life.

"The world hasn't stopped turning, and companies with a foreign exposure seem to continue to surprise to the upside," says Jordan Kimmel, a hedge fund manager at Magnet Investing of Randolph, N.J. "It's clear that the US is in a slowdown and it's just as clear that the standard of living around the world is rising. When the US catches cold the rest of the world doesn't, in fact, get pneumonia anymore."

Yet Kimmel calls the market "stock-specific" and warns against jumping back in with both feet as stocks continue to look for solid ground.

"I definitely like to see companies with a great deal of foreign exposure," he says. "I wouldn't start jumping in with abandon. There's a lot more issues in financials and I think the market has a lot of confidence that it still needs to earn back. But this is definitely constructive. It's one step forward."