What have earnings told us thus far?

S&P 500: +14.31 (+1.68%)

I’ve spent a lot of time talking covering the earnings releases of our Approved List companies. What are some of the things we have learned from earnings thus far?

1. Information technology will lead us out of the downturn. It seems like this sector more than any other thinks that demand has bottomed out. Heading into the downturn with historically lean operations and piles of cash has allowed these companies to invest in future growth while other sectors are scrambling for cash. Even more, businesses will likely loosen the purse strings first for IT spending, which can save money and enhance efficiencies.
   
   
2. Defense firms are not down and out. Several defense firms raised earnings outlooks this week and were optimistic about the changes in U.S. defense spending. A massive stimulus plan along with ambitious healthcare initiatives led many to assume that defense spending would decline going forward. These concerns dragged down valuations across the defense industry; however, these concerns overlook the stability of a U.S. defense budget slated to grow 4 percent in 2010 – a growth rate that would make many industries jealous.
   
   The proposals represent a strategic shift toward enhancing the military’s capabilities to fight today’s wars in Iraq and Afghanistan and future ones like them. Of course, this means there will be winners and losers, some of which are clear at this point, but nothing is certain until the budget is finalized.
   
   
3. Drugmakers face an uphill battle in the near-term. Signs of pharmaceutical sales weakness have been blatantly obvious in earnings reports. People have curtailed visits to the doctor and fewer are starting new therapies for chronic conditions. Increased use of cheaper generic drugs also softened overall sales growth.
   
   A potential economic recovery and changes in U.S. healthcare policies could help bolster demand for pharmaceuticals after this year, but mitigating growth will be another wave of patent expirations for blockbuster brands in 2011 and 2012. In addition, Obama’s healthcare initiatives targeting branded-drugmakers has stoked fears of price control.
   
   
4. Banks’ earnings reports would make Houdini proud. Goldman’s results were boosted by an “orphan” month. Wells Fargo’s earnings were helped by an accounting maneuver used last year that has since been banned. Equally disturbing was their disclosure of a $109.8 billion balance sheet line item called “other assets;” whose largest component was $44.2 billion item ever so eloquently labeled as “other.”
   
   J.P. Morgan, Bank of America, Citigroup, and others all had sizeable trading profits that made them profitable in January and February. Some suspect this was a result of cash-thirsty AIG unwinding their portfolio of default-credit protection. In the process, unwittingly or not, AIG made massively profitable trades to the banks. This is not sustainable.
   
   

Analysts may have finally become negative enough. One problem during the past few earnings seasons has been the unrealistic profit expectations from Wall Street analysts. This week, however, we have seen big rallies on earnings reports that were better than the worst-case scenario. Granted only 35 percent of S&P 500 companies have reported and many of the biggest surprises were in the financial sector.



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Peter Lazaroff, Junior Analyst