April is the best performing month of the year for the Dow Jones. April also hosts the first-quarter earnings announcements, which will kick off with Alcoa on April 11.
Aside from good seasonality, April also offer some potholes, earnings might be one of them.
Many corporations have been cost-cutting their way to impressive profits. Multi-national corporations have benefited from a weak dollar and strong exports. But regardless of how they got to higher profits, it has raised the benchmark and investor’s expectations.
When it comes to profits, the past may come to haunt the present and the future. Why?
If you under-promise it’s easy to over-deliver. This principle applies to the quarterly earnings ritual. Coming from the depressed 2009 lows, there was a lot of room to grow. Corporate cost cutting and firing led to quick double-digit growth.
Following several quarters of higher than expected earnings, the profit margin for the S&P 500 is at about 8.2%. According to Standard & Poor’s, the profit margin over the past 15 years has averaged about 6.1%.
Based on Federal Reserve data, corporate profits as a percentage of national income were 12.7%. The average since 1951 is about 10.5%.
A broader measure of valuation looks at domestic stock market capitalization as a percentage of gross domestic product (GDP). In March 2009, this number was about 55%; today it’s about 95%, close to the level where a mean reversion tends to take place.
Mean reversions are mean in the sense that they don’t announce their appearance. Mean reversions take place when least expected.
It can take longer than expected for the mean to revert, but it’s safe to say it will ultimately happen. In 2007 nobody saw the mean reversion (stock market crash). In early 2009 analysts were busy lowering their earnings forecasts just as stocks put in a significant low.
Based on the investment community’s collective bearishness in early 2009, the ETF Profit Strategy Newsletter issued a strong buy signal on March 2009. Within the next three months, the major indexes ETFs like the SPDR S&P 500 (SPY) and Dow Diamonds (DIA) gained around 45% and kept going.
Two years later, stocks have arrived at the opposite side of the spectrum.