Cautiously Optimistic

Not to get carried away and suggest that the market can do nothing but move higher, but rather point out that we just passed the year mark of the “collapse.” Therefore, more stocks are hitting new 52 week highs recently than say two weeks ago even though the market itself was actually higher then. The technology sector ($XLK) has actually seen a decrease in new highs over the past two weeks while most other sectors have seen increases. Earnings will be the key to whether or not this current trend has any staying power (or better yet, the reaction to earnings).

Q3 earnings season officially kicked off last Wednesday when Alcoa ($AA) reported better than expected earnings. Last quarter, nearly 70% of US companies beat earnings estimates and it was no secret that the bar was set pretty low. Add to that the fact that over the last four weeks the analysts have actually raised estimates for nearly 650 companies, while lowering them for nearly 400, and it begins to look like we might be in for a case of over correction on the placement of the bar. Time will tell, but Alcoa’s earnings beat, I believe, had more to do with the decline of the USD than anything else.

Another piece of information to consider regarding earnings is that of revenues and how the “top line” will come in this quarter. The last quarter saw a high percentage of companies beating the bottom line but about 1/2 were beating the top line. Judging by the nearly 200 companies that have reported since 9/1 it looks as though we are in for more of the same with a slightly higher percentage of top line estimates being met. If you are a student of the market then you would know how much importance is being placed on that top line as companies can only slash so many jobs and make so many cuts before it begins to show.

I believe it’s necessary to be prepared for a move lower here as the top line will not impress and the recent profits from last quarter’s “softball” will fade. As always, I have been building a watch list of stocks that look vulnerable to a downside move. In fact, each week I enter a few shorts and more times than not I get stopped out for a small loss. If earnings are indeed good and the market continues to move higher, I’ll continue to stick with what works. However, I prefer to be proactive rather than reactive and feel as though over the years it has helped me stay in the game. As a result, I’m always looking to play both sides of the market.

My biggest fear though is that the top line continues to be ignored and stocks move higher through this earnings period. Such action would beg the question of whose behind the curtain on this “rally” that the markets are in.