Ramblings of a Portfolio Manager

It’s Summer—Good Time To Have a Nice BOD

Earnings season “officially” kicks off this evening with the arrival of Alcoa’s second quarter earnings report. The talking heads in the financial media have been analyzing this season and its relative importance to the markets for weeks now. The general consensus is that, while second quarter earnings will be strong—perhaps even stronger than expected—guidance from most management teams will be cautious to tepid at best. Europe, the ongoing anti-business attitude from the Obama Administration and the prospect of higher taxes next year are all to blame for the expected downbeat guidance. Of course, as most investors are aware, the market discounts what it expects to happen, not what has already happened and so if Management guidance is poor, then we can expect stocks to fall further. Or can we?

As we have mentioned, the financial press has been talking about this earnings season for weeks now—ever since the market started to swoon in May. As CNBC said this morning, the sentiment and expectations are “awful going into this reporting season.” Comments like that signal to us that, most likely, the markets are already discounting the poor guidance everyone is talking about. With the major indices all down over 10% from their April highs, one can make the case that quite a bit of negative news has already been baked into current stock prices. Furthermore, with all the talk on the airwaves and internet about the expectations for guidance, it is hard to believe that there is anyone remotely interested in the capital markets who isn’t already braced for bad news.


We believe that the market is setting up for a good “buy on the dips” opportunity in stocks. We’re not necessarily talking about buying on dips in the equity market overall so much as buying on the dips that may occur in the first hours or days of trading in stocks that have just reported, with Management giving weak guidance. “But wait!” you say. We just said a fair amount of negative news is already in the stocks. Might they not actually jump on weak but not disastrous guidance? Perhaps, however, at the margin there is always a hair trigger trader or two in a stock with wishful thinking regarding an earnings report. We suspect that many stocks will have initial drops upon weak Management commentary, analyst downgrades (they love to downgrade a stock after the bad news comes out—saves them work on hard forward-looking research) and earnings cuts but that most will recover within a relatively short time—perhaps in some cases the same day. We’ve seen this type of behavior before—most recently in March-April of 2009, which became a signal that all the bad news was in the market. Not that we’re suggesting another 60-70% post-earnings season rally, just that this time around, a nice BOD might just make you some money.