The Devil is in the Details

(September 18, 2002) In our last market update we mentioned how most investors know that September is statistically the worst month to be invested in the stock market. We also mentioned that if you look for bad news you would find it and create your own self-fulfilling prophecy of a bad September. Then, investors trade and act accordingly and the next thing you know, we have another negative month. The problem with this is that too many investors are just focusing on the headlines and not the details of the business news. Inside the details, there are often many positives that give us encouragement that this economy is about to grow, not to slow down.

Case in point is an article posted on 7/16 on the web site www.cnnmoney.com. The title of the article is “Here Come the Warnings” and it goes on to profile how the third quarter of 2002 is likely to have more negative earnings surprises than last year. Although earnings warnings are never really good news, since they mean some company did not hit their earnings target, the warnings need to be viewed in a cyclical context. Is the announcement of a “warning” coming after six great quarters in a row and the sign that a company is topping out in terms of its potential for growth? Or is the warning tied to a turn around after several bad quarters of performance and even though the company may earn 5 cents per share versus 6 cents, it is the beginning of a new positive trend.

The real story in the details of this article is in the last two sentences. The article sights that even though earnings warnings may increase “Still, overall third-quarter profits are seen rising 10.1% from year ago levels…If the gain holds, it will be only the second quarter among the last seven periods when corporate earnings enjoyed year-over-year gains.” The devil in the details is not that the warnings are increasing, but that the direction of profits is improving. We would much rather have earnings for companies rebounding off a bottom, with a higher level of warnings, than earnings topping out with low warnings, a la 2000 before the stock market bubble burst. You can see this economy improving, but you really need to examine the details behind the headlines.

Data source; money.cnn.com