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Weekly Market Commentary of July 6th 2009

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Earnings Season Preview

Four times a year investors focus on the most fundamental driver of investment performance: earnings. The second quarter earnings season gets underway this week. However, the companies that report early in the season are most often not the bellwethers they are commonly thought to be. We will not really know how results are shaping up until the end of the month when about half of the companies will have reported.

As companies report their second quarter results, we will be looking most closely at third quarter earnings guidance. The expectations for the third quarter matter more than results for the second quarter, since the economy showed signs of bottoming during the second quarter and investors are focused on the impact of this change in direction for profits. Second quarter GDP is likely to have been negative, reflecting shrinking economic output. However, in the third quarter GDP is likely to be positive, as the economy begins to expand after a year of contraction.

Last quarter we did not expect good earnings guidance, but instead noted that in that environment a boost to the dividend payment might signal more confidence in a recovery by business leaders than any guidance they were likely to give on the earnings outlook. During the first quarter and first quarter earnings season, we were pleased to see more companies increase their dividend outnumber or at least match those that had decreased their dividend in every sector but Financials, where most of the cuts were concentrated. For this quarter, the bar is not set so low. In general, market participants expect corporate leaders to express that conditions have started to improve and hold or raise their outlook for earnings in the coming quarters—if they don’t, their stock prices are likely to suffer.

Specifically, we will be watching for three things during the earnings season:

1. How the second quarter results for the companies in the S&P 500 Index compare to expectations—we hope to see most companies modestly exceed expectations
2. How the expectations for the third quarter change—we hope to see the median expectation for all companies rise
3. How the range between high and low changes—we hope to see it narrow, reflecting improving confidence as uncertainty surrounding the economic outlook fades

The average forecast by Wall Street analysts for each company in the S&P 500 results in a share-weighted estimate for the index of about $13.94 in the second quarter and $14.97 for the third quarter. The range of the best and worst cases—as seen by Wall Street analysts—for the profits of the companies in the S&P 500 is also worth watching. To collect this data, we have taken the highest and lowest analyst estimate for each company to derive the bull and bear cases for the S&P 500.

1. The bull case, using the highest estimate for each company, forecasts $18.47 in the second quarter and $19.09 in the third quarter
2. The bear case, using the lowest estimate for each company, forecasts $9.76 in the second quarter and $10.60 in the third quarter
3. Market participants will be reacting to how these numbers change over the course of the earnings season

We expect guidance to confirm or boost expectations for earnings over the next 12 months; earnings are expected to be $66, resulting in a forward price-to-earnings ratio (P/E) of 14. If the 2010 analyst consensus estimate of $73 and the current next 12-month P/E of about 14 hold at year-end 2009, the S&P 500 would end the year at about 1000. That outcome would be in line with our base case forecast for a modest gain for stocks in 2009.

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IMPORTANT DISCLOSURES Investing in international and emerging markets may entail additional risks such as currency fl uctuation and political instability. Investing in small-cap stocks includes specifi c risks such as greater volatility and potentially less liquidity.

Stock investing involves risk including loss of principal Past performance is not a guarantee of future results.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise and are subject to availability and change in price.

The opinions voiced in this material are for general information only and are not intended to provide specifi c advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your fi nancial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

© LPL Financial

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