Investors focus on earnings, not Ukraine, Gaza Strip

Concern for profits, sales at U.S. companies outweighs the what-ifs of geopolitical issues


Traders work on the floor of the New York Stock Exchange May 23. (BRENDAN MCDERMID / REUTERS)

After a few jitters over the crises in the Middle East and Ukraine, investors have used last week's stock market sell-off to buy stocks at slightly cheaper prices rather than ducking for safety.

Geopolitical concerns generally have a short-lived effect on the market, and investors clearly haven't wanted to be distracted by the what-ifs that might arise during conflicts with Russia and continued upheaval in the oil-rich Middle East.

Rather, their focus remains squarely on how U.S. companies are doing at growing profits and sales, instead of what could happen to earnings later if geopolitical tensions spread and intensify. The current earnings season is providing an encouraging snapshot of the present.

"It is still early in the second-quarter earnings season, but the results so far have been better than expected," Ameriprise Financial Chief Market Strategist David Joy said.

With about one-fourth of large U.S. companies reporting their earnings for the second quarter, more companies than usual are exceeding expectations and earnings-per-share growth is estimated at 5.1 percent, with sales growth at 3.4 percent, according to Thomson Reuters analyst David Aurillo.

That's not tremendous growth, but it's strong enough to calm recent concerns that investors paid too dearly for the profits companies can generate. Stocks are pricey, and if companies had failed to produce the profits that were expected for the second quarter, investors probably would have had little patience.

The downing of the Malaysia Airlines jet and battle in the Gaza Strip remind investors about geopolitical uncertainties, "but the calm in energy markets, despite fighting also going on in Libya, Iraq and Syria, is somewhat instructive," said Citigroup strategist Tobias Levkovich. "Note that the Tel Aviv Stock Exchange is about flat versus its levels at the end of May and is only down less than 3 percent from its 2014 highs, intimating the lack of concern about a broader regional conflict."

Five years into a powerful bull market in stocks, investors have been seeking confirmation that their expectations for corporate profits and the economic recovery aren't overly optimistic. Global industrial company Ingersoll Rand helped assure investors Tuesday when it raised its sales forecast for the rest of this year.

A number of retailers recently expressed concerns about consumer spending, but investors have been counting on companies that sell to other companies to be key drivers of growth in the next phase of the recovery.

In a survey of large investing clients, Ned Davis Research recently found the strongest expectations are for stocks of energy, technology and industrial companies — those benefiting if the global recovery continues to pick up steam. Professional investors have the lowest expectations for companies that rely on consumer discretionary spending.

Geopolitical concerns could make conditions more difficult for consumers if oil prices spike, but few analysts see that happening. Rather, they see gasoline prices coming down as supplies rise and as slow-growing economies throughout the world have only modest demand for oil.

Meanwhile, the fact that central banks throughout the world continue to stimulate economies "numbs investors and immunizes them against any bad news," so they may not be fully building geopolitical risks into investment outlooks, said Gluskin Sheff economist David Rosenberg.

In a recent global survey of professional fund managers by Bank of America Merrill Lynch, 61 percent of the managers said they were close to the highest exposure they've ever had to stocks in the past 13 years. Private clients also are holding unusually large exposures to the stock market.

When enthusiasm for stocks is high, a sudden shock like a geopolitical scare could prompt a sell-off.

"One of the biggest concerns is the impact on European earnings" from Russian sanctions, Deutsch Asset and Wealth Management wrote to clients this week. Russia is a key customer for European companies, so if sanctions weaken Russia considerably, European companies could feel the decline in spending.

The timing couldn't be worse, since Europe's economy has been fading again and some analysts think the eurozone is at risk of dipping back into recession.

Because large U.S. companies depend on European customers for about 20 percent of their business, a slide in Europe's economy also could have an effect on U.S. corporate earnings.

Yet, the "U.S. economy should prove remarkably resilient, which would augur well for a secular bull market," said independent strategist Ed Yardeni. He notes strength showing up in rising loads of chemicals and petroleum products in U.S. rail cars, auto sales at cyclical highs of 17 million units in June and manufacturing activity in the Philadelphia area that grew in July at the fastest pace in three years.

Twitter @gailmarksjarvis

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