This week there were no position changes in the Sector Plus model. Our current three positions are SOXL, ERX, and DRN. To open next week, we will remain in those three ETFs.
The SPY closed the week down -0.81%. The ETF Sector Plus model was down -1.99%. The ETF Sector Plus Strategy is up +42.0% year-to-date compared to its benchmark, the SPY, which is now up +6.45% year-to-date.
This Week’s Strategy Lesson: Earnings Season
We kicked off earnings season this week. It is a quarterly event driven primarily by the reporting of profits, business conditions, and forecasts of the major U.S. corporations. While our strategies invest in ETFs, which provide a layer of insulation from the direct effects of the performance of individual companies, we are not immune to the broader trends that emerge as more and more companies report.
Even the Country funds can be effected by U.S. corporate earnings—since about 45% of the S&P500 corporate revenues come from overseas. The U.S. earnings season can tell the market a lot about the health of many international markets.
We thought it would be useful to go over some of the key concepts and things to watch for this earnings season.
10-Q
U.S. public corporations are regulated by the SEC and are required to file quarterly reports, called a “10-Q.” They contain the company’s income, balance sheet, and cash flow statements as well as commentary and forecasts. These summarize some of the basic elements of health and performance for the company, i.e. what came in (revenue), what went out (cost of goods sold), and what is leftover (earnings).
It is often not about absolute numbers but trends in performance results and forecasts for future profits that investors are interested in. Stocks are only valued for earnings or the promise of future earnings.
Longer term investors usually look for improving business conditions or rising profit margins rather than focusing on one-time charges or write-offs that can change the reported earnings number in any quarter but does not fundamentally change the long-term value of a company.
Broad Market Analysis
While investors in individual stocks are often most interested in the specific reports of those companies they follow, it is the broad aggregate performance of all the major companies that determine the success or failure of each earnings season. When you average the performance of all the companies you can get an idea of whether things are generally improving and to what degree.
We ended the first quarter earnings season with average earnings growth beating by about 1.3% and nearly 70% of the companies reporting beating their earnings expectations. Admittedly, the bar was set lower due to all the concerns about weather related slowdowns, but the majority of companies were still able to “outperform.”
This communicated to investors that companies were doing better than expected and business conditions might be improving or at least getting back to the longer-term growth expectations. High earnings growth generally means that the market can support higher valuations and stock prices.
Things to Watch For
While we won’t know the overall performance until we are deep into earnings seasons, there are many companies that are considered “bellwethers” in that they are the leading company in their sector or group and their performance can often predict the performance of other similar companies.
Alcoa, an aluminum manufacturer, is one of these companies and kicked off this earnings season with a substantial beat on earnings. Pay attention to other key players in different sectors as they report.
Another thing to watch for is improving revenue. Corporations have been able to grow earnings primarily by cost cutting and improving productivity. Sluggish revenue growth indicates that the health of the consumer has still not returned to pre-financial crisis levels.
While our ETF models do not take any direct trading signals from the performance of earnings season, indirectly, the performance of sectors and corporations that make up the country funds ultimately drives our Trend Strength Indicator and helps determine what ETFs we are in.
The Current Condition of the Model
For the Sector model, we remain in SOXL, ERX, and DRN. ERX and SOXL sold off their highs, while DRN made up for the two laggards. No position changes are imminent in the sector model but stay tuned to the daily updates should there be any changes.
Here is a summary of the weekly performance of all the ETFs that the strategy monitors:
Best wishes for your trading,
James Kimball
Trader & Analyst
MarketGauge