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Investors too quick to accentuate the positive?

Investors too quick to accentuate the positive?

In an effort to accentuate the positive, investors might be overreacting to quarterly profit reports. That could be setting up the U.S. stock market for a correction, which means picking the right stocks at the right time is key.
Many of the companies reporting improved profits from a year ago accomplished it by cutting costs through layoffs and other belt-tightening measures. Few actually saw profitability rise through increased revenue. Even though those beating expectations helped drive investors into the market, the reality is that about two-thirds of the companies reporting second-quarter results actually posted poorer performance than a year ago.
"Companies are reporting horrible year-over-year comparisons both on the revenue and the profit line _ typically negative double digits on both accounts," said Paul Larson, equities strategist for Morningstar Inc. "But I think what the market may be looking at, and reacting positively to, is the fact that it's not worse than what the market was expecting."
Investors appear to be looking beyond this quarter with the belief that the worst is over.
Indeed, the S&P 500 Index has risen 12 percent during earnings season.
"The stock market is a forward-looking beast," Larson said. "What the market going up tells us is that the market is anticipating a recovery at some point in the not-to-distant future."
Historically, a stock market recovery usually leads the real economic recovery by six to nine months.
RECOVERY EUPHORIA
Stock market performance is very much a product of an expectations game.
In the second quarter, for example, more than 70 percent of the companies reporting beat analyst estimates. And it appears the market is celebrating that fact, even though there is some belief that earnings expectations were ratcheted down, giving companies a relatively low bar to beat.
All told the S&P 500 Index companies are reporting lower profits than a year ago. Last week around 200 of the index companies had reported and about 137 posted lower earnings. More than 100 additional companies reported this week with similar trends continuing.
So, why is the market reacting so favorably to results that are less than stellar?
"We describe it as recoveryphoria," said Guy LeBas, chief economist at Philadelphia-based Janney Montgomery Scott, a financial services provider. "We see euphoria over the prospect of recovery that we don't believe in the short-term is likely to be realized. We're kind of cautious on that front."
He said a primary concern is whether the optimism will set investors up for disappointment if some of the rosy view fades and the market falls back when it appears a quick economic recovery isn't imminent.
"There is a potential for that," LeBas said. "Keep in mind the way the market goes up is there are more buyers than sellers so optimism can drive a market..."
That impact of a shifting mood was illustrated on Tuesday when the consumer confidence report fell short of expectations and several more companies reported earnings that disappointed. That was followed by the durable goods report on Wednesday that showed orders for big-ticket items from U.S. factories down 2.5 percent in June _ four times lower than economist expectations.
For those two days, the market's upward momentum paused, albeit briefly before it edged forward again Thursday and Friday.
This year, the S&P 500 sank to a 12-year low on March 9, but has steadily climbed and is now 46 percent higher.
LOOKING AHEAD
A fluctuating market is what investors can expect in the coming months.
"My expectation is that you're going to have a prolonged recovery period that's going to make it very challenging for investors to stay focused," said Mickey Cargile, managing partner at Midland, Texas-based WNB Private Client Group.
He believes that staying out of the market will be more costly than taking some risk.
"Staying on the sidelines in cash right now has a very high cost and I think it's time to start reallocating that money and maybe quit being so afraid," he said.
His advice to investors is to reflect on the feelings they had when the market bottomed and assess how much risk they're willing to take on.
Investing at a time when a market is climbing out of an abyss can be bumpy. Some advisers believe the market as it stands now has jumped too far and could be due for a fall. A sustained recovery requires consumers to return to spending because their activity makes up about 70 percent of the U.S. economy.
"I think that the market has overextended itself," said Tom Hepner, an investment adviser with Ruggie Wealth Management in Tavares, Florida.
He believes a realistic S&P 500 level is between 900 and 915 and there is likely to be some correction along the way. The index ended the day Thursday at 987 and some market watchers began talking about hitting 1000, a level not seen since November 2008.
Hepner believes the strategy of dollar cost averaging is the best approach for investors to get back in the market. Getting some money back in stocks now then gradually increasing your investment over the next six months.
That would help smooth out any bumps likely to occur as the economy begins to pick up and sustained recovery grabs hold.
WHAT RECOVERY LOOKS LIKE
Even those who hold a cautiously optimistic view believe the broader economy and markets have bottomed out. The remainder of 2009 likely will show gradual improvement. By the fourth quarter _ the year anniversary of the markets' swift slide _ companies should be showing improved year-over-year revenue as consumers ease back into spending. Once that happens, profits will rise, too, on improved efficiency from having cut costs so deeply.
In some cases, hiring will begin as companies begin to gear back up for increased production.
Morningstar's Larson said his view is that overall stocks are currently valued about right. The tough thing to realize is that they're priced about 50 percent more now than they were in March. So, if you've hesitated, you've missed an opportunity.
That simply points to the fact that getting back into the market strategically by picking entry points on quality stocks is not a bad idea but he observes: "I don't know if we can necessarily say today is the table-pounding opportunity of a lifetime."