Making Money Alert
Earnings Are the Key
04/12/2007
After a tough bout of selling throughout the first two weeks of March, the market managed to do what it has done so often in the recent past by mounting a healthy comeback. The final half of March and the first two weeks of April brought renewed confidence in stocks. That renewed confidence in equities is at a critical juncture this week.
Why are things critical right now? Simple: earnings. The entire market is waiting on the report cards of corporate America that will begin rolling out this week. The report cards will tell us if this market is headed for the honor roll or if stocks will be sent for remedial education.
The general consensus out there is that many companies may post only tepid numbers for the first quarter. Soon we'll see if the overall slowdown in the economy has had a big impact on the corporate bottom line. I suspect that earnings will be only modestly positive, with the important guidance for the next few quarters reflecting an overall contraction in corporate growth.
If we get some modestly negative news about earnings going forward, we could see a bouncing around of stocks akin to what happened throughout March. Better-than-expected numbers and healthy outlooks could send the market surging to new 52-week highs. However, the flipside of this coin appears if earnings and guidance come in well below expectations. If earnings and guidance fall short of expectations, we could retest the lows we saw in March. (See the chart below for a full view of the March volatility).If we get some modestly negative news about earnings going forward, we could see a bouncing around of stocks akin to what happened throughout March. Better-than-expected numbers and healthy outlooks could send the market surging to new 52-week highs. However, the flipside of this coin appears if earnings and guidance come in well below expectations. If earnings and guidance fall short of expectations, we could retest the lows we saw in March. (See the chart below for a full view of the March volatility).
As I've mentioned, I really think we are at a critical market juncture here. Earnings and economic news will be the key going forward. Right now, the bulls are waiting for some kind of solid news to justify their optimism. Those in the bearish camp are fearful that we haven't seen the last of the correction that began with the Feb. 27 plunge of 416 points in the Dow.
The way I see it, the best approach for investing in stocks right now is cautious optimism. I do think the market is headed for a rally sometime this year, perhaps even very soon. However, waiting for confirmation on the earnings front before making any big bets only makes sense at this critical juncture. If we get lackluster earnings over the next several weeks, then caution will serve you well. If, however, we see this market take off on good news, you'll have more than enough time to get into stocks without missing any major upside.
In the meantime, I think the best way to play this market is to pick your spots with sector funds. Right now in my Successful Investing advisory service, we are allocated to an energy exchange-traded fund (ETF) that gives you exposure to the best energy companies around. Given the big surge in oil and especially gasoline prices, I think we are in a great spot to profit from our energy exposure.
If you want to find out more about this fund and how to take advantage of the volatile energy sector with Successful Investing, click here.
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IS IT TIME TO SHORT REAL ESTATE?
Hi Doug,
At what point do you think would be a good entry into a short real estate fund such as the ProFunds Short Real Estate Investor (SRPIX)? With all of the current negative news, seeing lingering "for sale" signs, and talking to builders I anticipate a long, hard year for the building industry. Do you think that it is a good opportunity to short real estate or what would you see as a reason to enter?
Thanks, Richard
First, let me say that I like the way you are thinking, Richard. There is no doubt that the real estate sector is headed for a tough time in the months and maybe even years to come. But the question of how to profit from this likely slump becomes a bit more complicated than just buying the ProFunds Short Real Estate Investor fund.
This fund shorts the Dow Jones Real Estate Index, a proxy for the Real Estate Investment Trust (REIT) sector of the economy. In fact, over 90% of the Dow Jones Real Estate Index is comprised of REITs. The sector, represented below by the iShares Dow Jones Real Estate Index (IYR) fund, has been a stellar performer even amidst the warning signs in residential real estate.
I think it is going to take a bigger downtrend in the overall market and a lot more economic slowing before REITs start pulling back enough to short via the ProFunds Short Real Estate fund. A slowdown in residential real estate has not translated into big worries for REITs, at least not yet. So, while I like the way you are thinking with respect to moving in on potential opportunities, I do not think you can use the REIT sector as your shorting opportunity.
If you are looking to short something in the housing space, consider shorting the homebuilder ETF, the S&P Homebuilder SPDR (XHB). As you can see by the chart below, the homebuilders' sector has had a really tough time of things lately.
Notice that XHB has dropped below both its short-term, 50-day moving average (red line) and its long-term, 200-day moving average (blue line). This situation is not good news for those who are long on this ETF. But it does present an opportunity for aggressive investors looking to short the sector. I suspect this downtrend is going to persist for a while, as the subprime mess unravels further and puts the brakes on more homebuilding.
Once again, the best way to play the short side of the real estate space is not through REITs. The better way right now is by shorting the homebuilders.
THE REAL ESTATE ROLLER COASTER
I came across a great web site recently that I wanted to share with all of my Alert readers. The site is speculativebubble. The site's creators put together a "virtual roller coaster ride" that tracks real estate prices since 1890. I invite any of you even remotely interested in home prices to check out this fun little journey. As you'll discover, the road in real estate has been anything but straight up over the past century.
Depicted graphically in the chart below, we can see how home prices have gone through many boom-and-bust cycles.
What is frightening is the severely elevated valuations we currently are seeing. Can we really expect, by historical standards, that prices are going to keep climbing unabated forever?
This chart can be found in Robert J. Shiller's great book, "Irrational Exuberance." In this seminal work on market cycles, Shiller indicates that during every speculative bubble there always was widespread consensus that high valuations were justified by each market's special circumstances.
He also found that every large market correction seemed to result from popular consensus rather than specific events or news. Shiller says that past bull and bear markets, though often based initially on sound fundamental reasoning, fed upon themselves to go beyond what the facts justified. He challenges the efficient market theory -- demonstrating that markets cannot be explained historically by the movement of company earnings or dividends.
Is the real estate market the next big market bubble? History certainly seems to support that view.
To order Robert Shiller's "Irrational Exuberance," click here.
A FORMULA FOR SUCCESS
"Formula for success: Rise early, work hard, strike oil."
—J. Paul Getty
While not all of us can literally strike oil, all of us can rise early and work hard. Often, that's enough for us to strike our own version of oil in the form of recognition for our skills and efforts. So the next time you don't feel like getting up early or working as hard as you normally do, just remember that the road to riches waits for no man. Give your best everyday and you'll be much more likely to strike oil.
Wisdom about money, investing and life can be found anywhere. If you have a good quote you'd like me to share with your fellow Alert readers, send it to me, along with any comments, questions and suggestions you have about my radio show, newsletters, seminars, or anything else.