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This Week in the Stock Market: The S&P 500 "Earnings Recession" Rolls On

By Alex Dumortier, CFA - Apr 11, 2016 at 11:54AM

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Earnings season kicks off with first-quarter S&P 500 earnings expected to fall year over year.

The New York Stock Exchange. Image source: MarineCorps NewYork, republished under CC BY 2.0.

The first-quarter earnings season kicks off today, and U.S. stocks are higher in late morning trading on Monday, with the S&P 500 (SNPINDEX: ^GSPC) and the Dow Jones Industrial Average (DJINDICES: ^DJI) (DJINDICES: $INDU) up 0.15% and 0.25%, respectively, at 11:40 a.m. ET.

Those gains look inconsistent with the outlook for earnings: Based on the most recent data [launches Excel spreadsheet download] from S&P Dow Jones Indices, the S&P 500 continue to face an "earnings recession": First-quarter operating earnings are expected to fall by 0.2% year over year, which would mark the sixth consecutive quarterly decline.

The two sectors looking at the largest drops are Energy (down a third) and Financials (-19.1%). This week will provide some visibility with regard to the latter: Among the 15 S&P 500 companies that will report results are three of the Financials sector's largest components: JPMorgan Chase & Co. on Wednesday morning, followed by Wells Fargo & Co and Bank of America Corp on Thursday morning.

It's not worth fixating on the prolongation of the earnings recession: Given its magnitude of just 0.2%, it's quite likely the expected earnings decline will ultimately turn into a small increase once all of the numbers are in. The perennial dance that has companies under-promising in their guidance in order to beat the estimates of Wall Street analysts is still a crowd-pleaser.

(Not to mention that volatility in quarterly earnings bears little relationship to long-term stock market returns.)

Mutual funds: Find your flow
Last week, this column observed that "the flow of assets out of actively managed funds into index funds is turning into a tsunami that will ultimately require a wholesale reconstruction of the investment management industry."

In its March issue of FundInvestor, fund research house Morningstar calls it "Flowmageddon," and writes that, although "the trend has more positives than negatives [for investors]," it "presents fund investors with a new challenge in monitoring and selecting investments. You've got to watch flows."

That's a lesson that investors in Third Avenue Management's high-profile Focused Credit mutual fund learned the hard way last December, when the fund, which contained illiquid securities, collapsed in the wake of a rout in the high-yield market, forcing Third Avenue to halt investor withdrawals.

According to a fine in-depth article by The Wall Street Journal [link may require sign-up]:

[Then Third Avenue CEO] Mr. Barse became concerned about competition from low-cost index-tracking mutual funds, according to a former employee. Third Avenue attempted to launch "alternative" funds, or vehicles that resembled hedge funds, but most never clicked. One winner: the credit fund, which was launched in 2009 and quickly raced past $1 billion in assets.

Winner for whom? Vigilance and prudence are your watchwords.

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Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
$33,212.96 (1.76%) $575.77
S&P 500 Index - Price Return (USD) Stock Quote
S&P 500 Index - Price Return (USD)
$4,158.24 (2.47%) $100.40

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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