Investors may baulk at weak US earnings

Stocktake: Proinsias O'Mahony looks at the markets


US earnings season began yesterday, and numbers are not expected to be strong.

Eight out of 10 sectors have seen estimates decline since April; only four sectors are projected to report increased earnings; and the negative-to-positive earnings pre-announcements ratio is at levels unseen since 2001. Of late, investors haven’t cared. According to FactSet, companies that issued negative guidance in the last quarter actually eked out small gains immediately afterwards.

It may be, of course, that investors were not surprised, and that the news was already priced in. However, that seems unlikely. For one, over the last five years, negative announcements were followed by average falls of 1.2 per cent.

Secondly, companies that issued positive pre-announcements in the last quarter recorded average gains of 3.2 per cent, above the average seen over the last five years.

Investors were likely swept along by the overall market euphoria, and simply shrugged off bad news. With sentiment less buoyant of late, following Ben Bernanke’s tapering comments, investors may prove less forgiving towards weak earnings.

Golden opportunities unlikely

Gold investors enjoyed some respite last week, following the last quarter’s 23 per cent decline – the worst quarterly performance on record.

Despite the drop, there’s little talk of a bottom. Danske Bank, for example, sees a $1,000 gold price within three months. Gold sentiment among newsletter writers recently hit all-time lows, while hedge funds are betting on further declines – the number of short bets against gold is at near-record levels.

The fundamental arguments against gold – rising bond yields, low inflation and a valuation that many say remains rich compared to historical averages – are strong. However, with sentiment so ugly and technicals so stretched, a counter-trend bounce would not be surprising, says Barry Ritholtz of Fusion IQ.

However, he warns that any such bounce is unlikely to have a “happy ending”, with further lows ultimately awaiting.

“The bull market is broken, the prior narrative has utterly failed, and is no longer taken seriously, except by yellow metal jihadists and other assorted suckers.”

Still plenty of fight left in bull market

Legendary investor John Templeton famously said bull markets “are born on pessimism, grow on scepticism, mature on optimism and die on euphoria”. According to Merrill Lynch, there’s still no sign of euphoria on Wall Street.

Bullishness among strategists hit a 13-month high in June, Merrill admits, with an average recommended equity allocation of 49.8 per cent – up from the all-time low of 43.9 recorded a year ago. However, that remains way below historical weightings of 60-65 per cent.

“Given the contrarian nature of this indicator, we remain encouraged by Wall Street’s ongoing lack of optimism,” said Merrill.

Historically, when the indicator has been below 50, total returns over the next 12 months have been positive on every occasion, with median 12-month returns of over 30 per cent.

Don’t bet on six weeks of data
Track the market via a cheap index fund, or try and beat it with an actively managed one?

“When the going gets tough, active comes up trumps,” headlined FTAdviser last week, citing “evidence” that active managers “are worth the extra cost”.

The evidence? Active man- ager outperformance going back as far as, er, May 22nd.

We wouldn’t get too excited over a six-week period of outperformance – not when there is data going back decades that confirms that active funds consistently underperform. In the US last year, 80 per cent of active managers of mid-cap funds underperformed their benchmark, as did 66 per cent of small-cap mangers and 63 per cent of large-cap managers. The figures are similar for the last three- and five-year periods.

Some managers will outperform, of course, but it’s difficult to know who – picking yesterday’s winners doesn’t work. S&P data shows that, of the more than 700 funds in the top quartile of performers as of September 2010, just one in 10 were still there two years later.

The stats are similar for the UK, Europe and further afield.

Sometimes it’s worth going to the ‘Dogs’

Buying the world’s worst-performing stock markets is a recipe for outsized returns, says a new study.

Using data for 45 national indices, the study examined a mean-reverting strategy it termed “Dogs of the World”. Allocate one-fifth of one’s funds towards the five worst-performing indices over the past year, and hold for five years.

At the end of years two, three, four and five, the same percentage is invested in the five-worst performing markets over the previous 12 months. Every year after that, the oldest holdings are replaced by the five worst performers.

Returns were much more volatile, but also much better. $1 invested in 1997 was worth $2.94 in 2012, compared to $1.69 if invested in the MSCI world index.

The study is at