Earnings Season End Draws Near

For the most part, the major focus on earnings announcements has drawn to a close for the quarter. As of this morning, 463 of the S&P 500 companies have reported their quarterly earnings. Of those companies, 67.5% posted Earnings Per Share (EPS) higher than estimates. A few additional earnings reports trickled in this week. Most notably, Cisco Systems (CSCO) reported strong earnings on a turnaround in sales of switching systems. Overall, Cisco reported earnings of $0.47 per share, up from $0.42 per share a year earlier. In the company’s guidance, Cisco noted that China was a weak spot, as the company has been hurt by suspicions regarding their link to U.S. intelligence agencies. This caused Chinese revenue to fall 20%. Russian sales were also weak, falling 41%. This will be the last earnings call with John Chambers as CEO. He is stepping down after 20 years as CEO on July 26th, at which time 17-year Cisco veteran Chuck Robbins will take the reins. Cisco’s stock has been quite a roller coaster ride over the last twenty years, and investors will surely focus on the direction Robbins takes the company going forward.

While next week will not see a lot of companies report earnings, a few that are scheduled to report do warrant extra attention, regardless of whether or not investors hold the stock directly. Home Depot (HD), Wal-Mart (WMT), Lowes (LOW), and Deere (DE) are just a few of the companies scheduled to report earnings next week. The comments and outlooks these companies make on their earnings calls generally give investors an idea of how the U.S. economic recovery is progressing.

Jobless Claims Fall Unexpectedly:

Jobless claims last week fell by 1,000 over the previous week, to 264,000. This is much lower than the average economist estimate of 276,000. The four-week average fell to 271,750 and is the lowest reading since April of 2000. The four-week average is considered the more important number, as the data is “smoothed out”. The data found in the Labor Department’s report indicated that, while employers are not necessarily hiring at a high rate, they seem to be holding onto employees, as layoffs are falling. This signals that demand for workers remains high, a positive sign for the economy.

Eurozone GDP Advances 0.4%:

Eurozone economic growth grew at its fastest pace in two years, pointing to a regional recovery that is slowly picking up steam. Overall, the growth in GDP over last quarter was 0.4%, lower than the average economist estimate of 0.5%. The underlying numbers were a bit surprising; Germany’s GDP grew 0.3%, down from 0.7% last quarter and a very low number for a country that is generally considered the strongest eurozone economy. France and Italy surprised to the upside, with growth of 0.6% and 0.3%, respectively. While the numbers were seen as favorable, they were not so strong that the European Central Bank (ECB) will consider tapering its €60 billion monthly asset purchase program, set to continue through September 2016.

While most eurozone economies posted growth, Greece was a different story as the country fell back into recession in the first quarter. Greece’s GDP fell 0.2% over the previous quarter, following a 0.4% contraction in the fourth quarter 2014. Uncertainty surrounding the possibility of a default on Greek debt has weighed down the economy, as businesses, consumers, and bank depositors seem to be losing confidence in Greece’s ability to pay off its debts.

Yields Continue to Rise in Germany and U.S.:

Bonds have been selling off around the world, driving yields higher. As a refresher, bond yields and bond prices are inversely related; that is, when bond yields rise, prices fall, and vice versa. So a sell-off means yields are rising, and therefore bond prices are falling. In Germany, the 10-year bond is yielding around 0.64%, up from its low of 0.07% in mid-April. While it’s tough to say exactly why this quick sell-off occurred, there are certainly theories. One theory is that the rise in prices (fall in yields) was simply overdone, almost to “bubble levels” and this sell-off (rise in yields) is a long-overdue correction. This could certainly explain the rapid rise in yields, as investors tend to get the most over-exuberant right before a bubble pops. Speculators may have been buying these bonds simply on the expectation that yields will continue to fall, allowing them to book capital gains from the rise in price. When prices begin to turn, speculators exit quickly and the bottom begins to fall out.

Another theory is the widespread belief that Greece will remain in the eurozone, and this has impacted yields. With a Greek exit less likely (from the market’s perspective), investors see the eurozone situation as more stable and therefore do not require the “flight to quality” they previously demanded. The flight to quality over the last several months was buying German bonds, thus driving up the prices (and driving down yields). Now that the situation is a bit more normalized, some investors are selling their German bonds in search of yield.

The U.S. has seen a similar rise in yields, albeit less extreme than Germany. The 10-year Treasury has also sold off, increasing from 1.85% to about 2.28%. U.S. yields tends to move in the same general direction as German yields, so correlation certainly caused some of this rise. However, the U.S. selloff is also likely due to slowing economic indicators that have also slowed the rally in the U.S. dollar. Some economists see rising yields as, among other things, a sign that slower global growth and higher inflation could be coming. However, there is a lot that can and will happen between now and when this would take place. So while the rising yields are certainly something we will keep our eye on, there is no immediate threat.

Sell in May and Go Away?:

The media likes to produce several cute (and catchy) adages regarding investing. One that seems to always pop up this time each year is “Sell in May and go away.” The premise behind this is that, historically, May – October produces higher periods of volatility and lower returns than November – April. The thought is an investor should sell their holdings in May and re-enter the market in November. The Dow Jones Industrial Average (admittedly not the best measure of overall market performance) has returned an average of 7.5% per year during the November – April period since 1950. The May – October period has an average return of 0.3% over this same time period. Additionally, September is considered to be the worst month, return-wise. However, there are many reasons this trading adage is simply ludicrous.

First, the most obvious flaw with this is that it uses historical numbers. As we all know, past performance is no guarantee of future results and one does not have to look very hard to find a time when this didn’t hold true. The S&P 500 returned 7.12% for the May – October period in 2014, 9.95% in 2013, and 1.02% in 2012. In fact, this strategy fails about two-thirds of the time. And the 0.3% return cited above is still a positive return, which can compound over time.

Second, the historical returns do not take into account explicit costs, like commissions for selling each security and the taxes that would be due on them. An interesting study was done by InvestorPlace.com, where the author ran a simple analysis using the Vanguard 500 Index, which tracks the S&P 500. In the study, he “sold” the fund at the beginning of May and “bought” it back at the beginning of November. You can see by his chart below that, without taxes, this strategy only slightly underperformed the overall S&P 500 “buy and hold” strategy. However, when annual taxes were taken into account (the author used 25%), much of the gains were wiped out by taxes. A qualified account, like an IRA, won’t have these tax implications, but the commissions are still a factor that can drag on returns. While this is just one study, multiple other studies done generally paint the same picture and come to the same general conclusion.
Source: Investorplace.com

While there will certainly be some volatility over the coming months, it is generally best to ignore the media adages that promise returns based on an old adage. Formulating a strategy based on a calendar is as silly as it sounds. The fact that this has worked at all in the past is simply an anomaly (a 33% success rate doesn’t exactly scream success). Instead, a long-term focused, diversified portfolio is advisable, especially as this can be adjusted based on upcoming market expectations, something we are always looking at when managing portfolios…not just a few times a year.