"Less Bad" Is Indeed Better

Sleepy Bear

We are amazed by the negativity shown towards positive news events lately.

Yes, the economy is weak. Yes, the market could near-term reverse. No argument there.

Yet longer term, what matters for this market is where the economy is going, not where it is. That is the market’s uncertainty. Thus to avoid double-counting negative facts we already know, every new event must be viewed within the context of current expectations before judging it as positive or negative.

Case in point, the August payrolls data. Before you can argue whether it was good or bad news, you need to think about the realm of possible outcomes we had going into this event. Based on previous data, nobody thought that payrolls would stop falling in just a month’s time. The question wasn’t if they would fall, but by how much.

Thus while you can argue whether or not the payrolls trend improved, but you can’t claim the data was a reason to be bearish just because payrolls kept falling. That would be like saying global warming is getting worse just because August was hotter than February. Nobody expected it to be otherwise.

The same logic can be applied to negativity towards positive earnings surprises this season. The Big Picture, via Barrons, via Gluskin Sheff’s David Rosenberg, suggests that recent earnings surprises aren’t good news because the estimates they beat had been lowered from higher estimates calculated back in 2008.

The Big Picture: To date, 73% of Standard & Poor’s 500 companies reporting have beat Q2 earnings estimates. But as Robin Blumenthal points out this morning, “you would do well to ask: Which estimates?” Robin references David Rosenberg’s commentary on the subject. Rosie says the good showing is a function of when the estimates were made. His estimates for Q2 earnings/share is $13.94 – 30% below what analysts consensus at the end of 2008. December 2008 estimates for Q2 earnings were $19.92 — they were repeatedly sliced until they had fallen down to $14.15 as Q2 ended. While everyone seems to be excited about these beats, they are actually massive misses to the consensus just 2Qs ago.

Fact is, we already knew that latest consensus earnings estimates had been lowered substantially. The S&P fell from about 930 in early January to 676 in March partly due to the consensus outlook worsening. It then rallied as the economic outlook improved from “horrible” to “less horrible” and here we are today.

We also knew that companies wouldn’t beat their old estimates, since they were much higher. That would have been a truly unbelievable outcome. Hence to point out that companies didn’t beat the estimates from six months back to simply repeat what we already knew would very likely be the case. It’s double-counting.

Now within the range of reasonable outcomes for earnings, beating estimates was surely better than meeting or missing them. Thus these results came in at the positive end of the spectrum. This isn’t to say these earnings were great. Earnings were still weak versus where they had been. Just like the payrolls data was still ugly.

This market isn’t asking for great. It isn’t even asking for “OK” since it is still well below where it has been in the past. This market just wants to see the US coming out of a hole. Thus long-term bears must do more than remind us why things still aren’t great. They must show us why new data discredits the argument that the US has passed its darkest hour. Otherwise the economy is progressively “less bad”, which by definition, is better.

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