Earnings Surprises and the Fiscal Cliff - Investment Ideas

Believe it or not, there is good that can come of the U.S. partially going over the fiscal cliff; if you know what to look for and have the right strategy.

In theory, the U.S. actually went "over" the fiscal cliff, since the midnight January 1st deadline was not met. Lawmakers did clear the way for tax hikes on Americans making 400k or higher and raised the estate tax on large inheritances. But the details on the budget still have yet to be worked out and lawmakers agreed to extend the timeline on spending cuts by roughly two months, in which time the U.S. would face a potential default on their debt.

This semi-solution leaves investors cautious, but still hopeful. The reality is that aside from rising healthcare costs, most of the middle class will not see a major tax increase and should able to manage their expenses and continue to grow the U.S. economy in 2013 ... albeit slowly. This is part of the reason the markets are rallying today.

How Can This Be Good?

There are 14 stages of investor sentiment; these variations can be fairly easy to spot at times and illusive at others. Stocks often trend depending upon the psyche of investors, not always on hard fundamental data.

Interestingly enough, there is clarity amidst the chaos. As we enter into the New Year, there is no doubt that markets are somewhat cautious, as is the average American.

While I feel we are far from panic, despondency or depression, I think that there is a sense of "hope" in the marketplace, which actually puts us fairly close to the point of maximum profitability in the market's emotional cycle (see the chart below).

Before last earnings season began, I believe that markets were overly excited and closer to the "thrill" area of the psychological curve. In fact, if you look at a daily chart of the S&P 500 over the past 3 months, you can see these emotions play out in stock prices.

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In mid September, markets were completely euphoric running up into the elections, with the fiscal cliff just a twinkle in the eye of only the savviest investors. After the election results and woes about the cliff and future of the economy, the market quickly gave back 9%, changing the mood from elation to outright depression.

This reality check that was dealt by the cliff unknowns and cautious tone of analysts set the stage for us to profit as markets are now in a more realistic mood, expecting mediocrity at best.

My theory is further proven by the extremely positive reaction to a less than perfect solution; if markets were completely euphoric and overbought, I don't believe we would have seen such a bullish move.

While emotions can rule the markets much of the time, it is 4 times a year when stocks report their results (earnings) when objective overtakes subjective . If the subjective mood is not "overly euphoric" than stable objective data should cause stocks to rise; this works in the opposite direction as well of course.

A very smart man once told me that the brightest opportunities usually lie in the darkest of places. Sometimes when it feels like the worst time to be investing, that might be the best time to dip your toe in.

Resiliency in Earnings

I'd be lying to you if I said that corporate revenues are shooting up and that the average company is making money hand over fist. But I can say that there are three things that I feel very good about coming into 2013:

1) Corporations are lean and mean - The average American company has cut costs and economized their businesses to keep margins high and operate in a low growth environment.

2) Hoards of cash - We are seeing many companies stockpiling cash and equivalents, preparing themselves not just for the worst, but for the turn. The turn being an improvement in the economy and that cash is utilized for expansion, M&A, share buybacks and dividends.

3) Expectations low - As I mentioned last quarter, expectations were relatively low; but more recently the average share price and growth estimates have come down even further. This makes the reaction to a positive surprise that much more significant. Even though Q4 earnings won't be the strongest we have seen in years, stability and moderate growth should be enough, in the right stocks, to propel them higher. Keep in mind that average GDP growth estimates for 2013 are at 2% or less, which is very realistic.

These factors will help support the markets throughout the year and, with a little luck and continued stability overseas, the markets should hold their ground by the end of 2013.

The Hitch

Expectations are low for a reason; I wouldn't expect the overall market to see as good a return in 2013 as we saw in 2012. I also believe that the next two months or so, ahead of the spending cut extension, will hold stock prices down until investors have more answers. There will be "headline risk" associated with the details and potential for a downgrade or default, which will also keep volatility elevated (the S&P 500 had an average daily swing of 1.5% in 2012!).

This means that you have to be laser focused and step outside the box to find alternative investment methods to get superior returns. Defensive stocks won't cut it...

The "shotgun investing approach" is not the technique of choice as I believe the big winners will be few and hard to target with a still doubtful market. You will need an effective tool to do this; one that stacks the odds in your favor. Whatever method you choose, be sure to allocate your assets appropriately, reduce risk where needed and take or protect profits once you have them.

My approach is to target and study analysts' behaviors and actions ahead of a report to sniff out those companies most likely to beat earnings expectations.

The Most Accurate Earnings Whispers

Today, you are welcome to take part in our Zacks Whisper Trader service, which is the perfect way to add this type of diversity to your portfolio. Since most of our trades are shorter in duration, you won't have to be over-exposed to a market that is still susceptible to headlines. I can't share the details of our whisper formula, but it has achieved greater than 81% accuracy in targeting companies that beat estimates.

You won't make money 81% of the time, but being tipped off to positive earnings surprises BEFORE they are reported will give you a profound advantage over most other investors.

This will not be an easy quarter for the average trader, but many companies will still see their share prices break away (positively) from the market, which will most likely be stagnant to negative. So I strongly encourage you to look into our Whisper service. Please be sure to do it now, because heavy demand is expected, and your chance to access it closes this Saturday, January 5.

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Good Trading,


Jared Levy is a Zacks Rank Senior Equity Strategist with a broad international following and special expertise in earnings surprises. He provides private recommendations and commentary for the groundbreaking Zacks Whisper Trader.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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