Tis the Season to be Jolly, or is It?

September 5, 2008

No, it’s not Christmas in July, for those of you like me who remember when retailers would do “Christmas in July” sales. The season I am referring to is the earnings season that kicked off two weeks ago with Alcoa’s earnings report.

It may have kicked off two weeks ago, but it kicked into high gear last week as a number of Dow components and tech companies reported earnings.

But let’s go back to the beginning of earnings season.

Alcoa (AA) reported after the closing bell on July 9 and proceeded to drop 1.6 percent the next day. Sure, if you look at the chart now, it looks like they broke out due to earnings, but the stock jumped on rumors that BHP Billiton (BHP) was seeking a private equity partner for a potential takeover of Alcoa.

There were three other earnings tidbits the week of July 9-13 that investors should have taken note of - the earnings warnings by Motorola (MOT), Home Depot (HD), and Sears Holding (SHLD).

Jumping ahead to this past week, Tuesday evening we heard from Intel (INTC) and Yahoo! (YHOO) and both earnings reports disappointed investors. Intel and Yahoo! both dropped over 4.5 percent on Wednesday.

Investors were disappointed once again on Wednesday morning with Pfizer (PFE) and JP Morgan’s (JPM) earnings reports. Pfizer is the most widely held stock in the United States and it fell four percent on Wednesday. JP Morgan dropped over two percent.

So why did so many earnings reports disappoint in the last two weeks? I think it is because investor expectations got a little too optimistic. Last quarter was supposed to be the quarter that saw earnings slow down and for the most part, earnings were not that bad back in April and May.

Because the earnings season was not as painful as investors thought, they let their guard down and it boosted their confidence in what this earnings season would bring.

You have read it before in Investor’s Daily Edge that during earnings season, the only thing that matters are the expectations. That is why you see some companies beat estimates and go down and other companies miss estimates yet proceed to rise afterwards.

If the expectations ahead of the reports reach too high of a level, the company will have a hard time impressing the masses such that the stock moves higher. And if expectations are so incredibly low that the company can stumble over the estimates and impress the masses, the stock can’t help but go up.

I think that is why this earnings season got off to such a rough start. Investors just got too damn optimistic.

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