Earnings Expectations Low Enough for Most Firms to Beat Them

Stocks rallied out of the hole yesterday. And the financial media, which started the day reporting that pessimism about the economic recovery was driving stocks lower, finished by saying that improvements in credit markets were driving stock prices higher. 

Neither explanation gets to the heart of the matter.
"Buy the rumor, sell the news" remains one of the most important rules for investing. When it became clear that stocks were grossly oversold and the global financial system wasn’t going to self-destruct, investors bought stocks. In essence, they were buying the rumor that the economy would recover. 
There have never been any rosy recovery projections that investors could be disappointed in. Rather, now that we are at the start of the third quarter, the one most economists say will be the first to show growth in a year, it’s time for some actual numbers to back up valuations. 
According to Barron’s online, the current P/E for the Dow Industrials is 12.29. That’s not cheap, but it’s not expensive, either. Let’s call it just right. With little reason to expect any upside, investors will be inclined to take their profits. In other words, they are selling the news. 
*****It will be particularly interesting to see how this dynamic plays out during earnings season. My early read on earnings is that estimates are low enough right now that companies should be able to beat expectations. But what will they say about the future? And how will investors react? 
I don’t expect a lot of upside this earnings season. We’ll find out soon enough, Alcoa (NYSE:AA) reports today… 
*****It’s been a while since I answered any reader mail here in Daily Profit. Time to change that… 
Dan W. writes: I have been reading your newsletters for many months now and thanks for your talent. There is something I wanted to pass on. I grew up in the Far East and experienced communism with its May Day parades as an American dependant. I learned a most important fact even as a youngster that everything is or can be "owned by the state". What would prevent the Chinese government (communism) from taking over my stock if I invested in some of "their" companies in the near future? 
Normally when we talk about financial markets, there’s an underlying assumption that we’re also talking about free markets. The ideal of a free market is that investors and consumers are the ultimate regulators. If your business stinks, no one will buy your stock, debt or product. 
Of course, as has been proven time and time again, the ideal is not functional. From Carnegie and Vanderbilt to Enron to AIG (NYSE:AIG), it seems pretty obvious to me that financial markets cannot go completely unregulated because greed will motivate some people to behave in unethical ways. 
Investors must believe their money is fundamentally safe from deliberate fraud (but not necessarily protected from incompetence, poor market conditions, and unwise decisions). That’s what regulations achieve – you might lose money, but it won’t (or shouldn’t) be because the game is rigged. 
In my opinion, monopoly and anti-trust laws were America’s first attempt to move from laissez-faire capitalism to a sort of hybrid, regulated capitalism. Also in my opinion, China’s is approaching a similar hybrid capitalism, albeit from the opposite side of the spectrum.   
No need to debate the relative merits of China’s economic development. The point is that China well understands that the road to its prosperity means fostering domestic business and accessing the capital markets. 
So I don’t believe China’s communist government is any threat to domestic business. In fact, given China’s willingness to spend its currency reserves to support its economy, I’d say China’s government is a friend to its domestic business. 
And besides, investing in China can mean buying companies already owned by the government, like Petrochina (NYSE:PTR) or Sinopec (NYSE:SNP). I probably don’t need to remind you that American investors – including Warren Buffett – have done pretty well with state-run Chinese companies. 
Now, I don’t mean this to sound like an endorsement of communism. It isn’t. But I’m here to make money. And my sense is that China’s government is smart enough to know that it is China’s growing prosperity that keeps it in power. I can think of nothing that would threaten that prosperity more than a government takeover of a private business. 
On Thursday, July 2, I reported that there may be as many as 100 Chinese companies getting ready for an IPO (initial public offering). All it would take to completely shut China out of the global capital markets is for the government to take over a company. 
Just yesterday, Fiat announced that it was putting up $559 million for a joint venture with Guangzhou Automobile Group. Fiat’s obviously not worried about the Chinese government taking the operation over. You shouldn’t be either.
 *****As you probably know, I am very bullish on companies in certain segments of the Chinese economy. Energy and commodities, especially, will do well as China spends heavily on infrastructure to support its economy. I’ve been covering a few of them in my SmallCapInvestor PRO service to the delight, and profit, of my subscribers. Click HERE to find out more.


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