Correction or Bear Market?
by: Trade Radar Operator May 26, 2010.

The first quarter earnings season is pretty much wrapped up, and investors, with their short memories, consider it ancient history.

With markets in turmoil, the question is whether we are seeing a correction or something worse. As stocks struggle with their 200-day moving averages, it is clear that we don't quite have an answer yet. Certainly the blogosphere is lit up with bearish declarations while bulls, less exuberant than before, keep a worried eye on the charts.

Looking for guidance

One clue left over from earnings season may help us get closer to determining the future state of the stock market. Whereas earnings are historical numbers, out of date the minute they are released, company guidance is forward looking and provides the best assessment management has of the coming months.

I have been collecting earnings, revenue and guidance data for this earnings season and have amassed information on over 2000 companies. The following table provides the detail on guidance broken down by industry sector.

Here are some takeaways from the data presented above:

• Technology companies were most willing to provide guidance. Hopefully, this means many of them had clear visibility.
• Technology companies also comprised one of the sectors that had the most instances of Upside guidance based on the percentage of companies in the sector that offered any guidance at all.
• The Capital Goods sector actually had the best result in terms of highest percentage of Upside guidance at 37%, with a respectable total of 47% of sector participants offering guidance. This sector includes companies like the automakers (Ford (F), Honda (HMC), etc.), Lockheed Martin (LMT), McDermott International (MDR), Boeing (BA), homebuilders (Beazer (BZH), Hovnanian (HOV)), Alcoa (AA), General Dynamics (GD) and many more.
• Looking at the consumer sector, there is a mixed picture. Though the Consumer Services sector has only a modest 14% of companies providing upside guidance, the Consumer Non-Durables sector is reporting 27% and the Consumer Durables sector is reporting 13%. This suggests the U.S. consumer is regaining some strength though he/she is still a bit wobbly.
• The Finance sector remains one of the least optimistic sectors, with a relatively small percentage of companies providing upside guidance and the largest percentage of companies providing downside guidance.

Overall, 23% of companies offered Upside guidance based on the total number of companies that offered any guidance at all. A mere 9% of companies offered Downside guidance.

Conclusions

All told, 40% or the companies in my database offered guidance.

In general, I find it hard to believe that we are headed for another bear market when nearly a quarter of those companies that offered guidance are saying the outlook appears to be better going forward. On the flip side, it is hard to be too negative when only 9% of them are expecting their businesses to get worse.

While it is true that some managements may sugar-coat guidance in order to give their stock a short-term boost, eventually analysts and investors will see the true outcome. A stock that falls short of elevated expectations tends to plunge further than a stock that merely meets low expectations.

So short of another black swan economic event (a new Korean war, perhaps? the U.K. defaults?) I tend to believe that it is reasonable to take the preponderance of positive guidance as a sign of better times to come.

Correction or bear market? So far I'm leaning toward correction and considering it a buying opportunity.

About the author: Trade Radar Operator
I am a long-time individual investor with an engineering degree and an MBA. I worked in aerospace-defense for 15 years and have spent the last decade or so working for a large financial services firm. This academic, work and investing background helps me cast an informed eye on tech stocks, the stock market and the economy and also provides the skills needed to write the software that supports the various parts of the Trade-Radar.com website.
Visit his blog: http://traderadar.blogspot.com (http://blog.trade-radar.com)

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