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Sizing Up Earnings Season

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It's my favorite time of the quarter - as a trader.  I approach it like an offensive or defensive coordinator on one of the NFL playoff teams this weekend.  I study recent history to find strengths and weaknesses of the market and then I anticipate "plays" (price action) before they happen.  Let's talk about the planning phase first.

Analysts are constantly visiting companies throughout the quarter, discussing prospects, goals, outlooks, etc. with management teams.  They generally have a sense of how a company is going to report before they report.  They use this information to build positions throughout the quarter, usually leading to a rise in stock price (accumulation) into earnings.  Think of that old Wall Street adage "buy on the rumor and sell on the news".  Need a real life example?  Check out Alcoa (AA).  AA is the company widely recognized as the one that "kicks off" (another football term - sorry it's the Divisional Playoffs and I'm a HUGE NFL fan) earnings season.  Of all the Dow Jones industry groups, do you know which one has been THE best performer over the past month prior to AA's earnings report?  (drum roll please)

Aluminum.  

The Dow Jones U.S. Aluminum Index ($DJUSAL) had risen approximately 11% in one month before AA's report on Thursday evening.  That topped even the airlines industry ($DJUSAR), which is the group that seems to command the headlines.  But AA represents that "buy on the rumor and sell on the news" mentality so often exhibited on Wall Street.  Look at the AA chart:

AA 1.11.14

Alcoa disappointed traders after coming up a tad short on its quarterly EPS.  Technically, however, AA remains a very strong stock technically after holding both price and trendline support on massive volume Friday.  I expect to see AA back testing recent highs in the not-too-distant future.

Expect strong results in industry groups where prices have been soaring higher.  There's a reason for this outperformance into earnings season, although a "sell on the news" reaction cannot be dismissed.  That will likely set up the opportunities we'll be looking for.  Through Friday's close, and excluding aluminum, here are the best performing industry groups over the past month:

Tires - Consumer Staples - $DJUSTR +14.55%
Airlines - Industrials - $DJUSAR +12.75%
Platinum - Materials - $DJUSPL +10.71%
Home Construction - Consumer Discretionary - $DJUSHB +9.57%

That last name is intriguing.  The 10 year treasury yield ($TNX) has been rising since early May.  Home construction ($DJUSHB) is an interest-sensitive group that generally performs poorly during a rising interest rate environment.  Check out this chart:

DJUSHB 1.11.14

There was a clear inverse relationship in play between home construction stocks and 10 year treasury yields for much of 2013.  But the recent two month climb in yields has been met with buyers of homebuilders as we enter earnings season.  Home construction stocks were one of my least favorite industry groups moving into 2013, but with signs of economic improvement abounding, this is one of my favorites of 2014.  Recently, Lennar (LEN) posted excellent results, beating both top and bottom line estimates.  EPS came in at $.73 vs. $.62 estimates and revenues were $1.92 billion vs. $1.88 billion expected.  Technically, LEN made a significant breakout as well and appears poised for further gains.  Take a look:

LEN 1.11.14

EarningsBeats.com identifies stocks that reflect BOTH strong fundamentals and strong technicals and then allows these stocks to hit critical support areas just like LEN did for an opportunity to trade and profit - with less risk.  On Tuesday, January 14th I'll be hosting a FREE webinar to discuss the 60-70 EarningsBeat stocks from Q4 2013, going over the performance of each in detail to prepare for the next round of earnings season trading candidates.  You can register for this event by CLICKING HERE

Happy trading!

Tom Bowley
Chief Market Strategist/Chief Equity Strategist

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Tom Bowley
About the author: co-founded Invested Central in 2004 and served as the site's Chief Market Strategist for more than 10 years. Invested Central provides stock market education and guidance for those interested in making their own financial decisions. During his tenure at Invested Central, Tom co-hosted Market Open LIVE, a national radio broadcast that covered many of the largest markets across the U.S. In addition, he has spoken at various conferences throughout the United States and Canada and has taught thousands of traders across the globe how to trade equities more wisely with an emphasis on managing risk and intermarket relationships. Learn More
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