During our meetings with clients and prospects in mid-June, we expressed the view that the spring market correction - driven mainly by global macro concerns - would shift to a more positive tone as the US earnings reporting season for the second quarter got underway.
Furthermore, we felt this market turnaround would have persistence as investors not only came to recognise the good results from the second quarter's profit figures, but appreciate more fully the benefits from the swiftest and deepest corporate restructuring witnessed during our careers was just starting to become evident.
Guidance for profit margins and returns on capital continue to move higher on streamlined asset bases, regardless of the slow pace of economic recovery, and will do so over the next 12 to 18 months.
As at 9 August 2010, positive earning surprises overwhelmed the negative as evidenced by the fact that out of 89% of companies that have reported quarterly profits results thus far, 75% beat the average of analysts' earnings estimates, and 63% beat the average of analysts' revenue estimates.
Also, the highest positive ‘beat rate' on revenue has been in the consumer discretionary and industrials sectors, obvious economically sensitive areas and two sectors where the PSigma American Growth fund is overweight.
Aside from the status of corporate earnings, one other factor we would like to bring to attention is the increase in market correlation measures over the last few months. In other words, we have seen a rise in the proportion of US stocks moving together. Part of this may have been due to the macro-led concerns mentioned above, and we expect it to abate as the year progresses.
This dynamic, however, is positive over the intermediate term in the sense that, as active stockpickers, we can capitalise on this possible near-term misalignment of differentiation by investors but, perhaps, need a higher level of patience to let relative stock ideas play out.
For the year, we expect to see a continuation of corporate earnings growth across the board but a growing division between companies within industries as the higher than average correlation amongst stocks in general unwinds.
In the PSigma American Growth fund, we remain exposed to those higher quality companies that can capture productivity gains further, such as Wal-Mart, and Avon Products; those that can grow their revenue and profits through strong franchises, such as Starbucks, and Microsoft; as well as selective more cyclical companies that were well ahead of their peers in restructuring and downsizing, including Caterpillar, and UPS, giving them tremendous profits leverage on streamlined asset bases regardless of the slow pace of economic recovery.
James Abate is the manager of the PSigma American Growth fund
