Have investors got ahead of themselves? Maley

The US sharemarket came roaring ahead overnight, bolstered by a blistering first quarter profit result from JP Morgan Chase & Co, and in defiance of warnings that all the good earnings news is already factored into the market, and that investors are set to sell the news.

JP Morgan Chase – which is the second largest US bank measured by asset size – reported profits of $US3.3 billion in the first three months of 2010, a blistering 55% increase over the same period a year earlier. The bank’s result reflected strong trading earnings – particularly in fixed income and equities – and a sharp decline in provisions for problem loans.

The bank’s boss, Jamie Dimon, told reporters there was now a “clear and broad-based improvement” in the economy, which could possibly result in a “strong recovery”. The chances of a double dip recession, he said, were now “rapidly going away”.

JP Morgan Chase’s surge in first-quarter profits comes hot on the heels of a Intel Corp’s staggering results released earlier in the week. The Silicon Valley chip giant’s quarterly profit nearly quadrupled in the first quarter to $2.4 billion, allowing the company to report its strongest first quarter since the company was founded in 1968. The company’s results reflected strengthening technology spending by consumers and companies. Intel supplies the processors that run about 80% of the world’s personal computers.

Dimon’s enthusiasm for the economic recovery was also backed up by figures released overnight that showed retail sales jumped 1.6% last month, the biggest increase in four months, and well above the 1.3% increase that economists had tipped.

Even US Federal Reserve chief, Ben Bernanke took a slightly rosier view of the economy than he has in the past. Appearing before a congressional committee overnight, Bernanke said the data indicated the US economy was on the path to “a moderate economic recovery in coming quarters.” He added that the pace of the economy would depend on whether spending by consumers, and investment by companies, was enough to make up for reduced government support.

However, Bernanke also warned that high unemployment, weakness in the housing market and massive budget problems of state and local governments remained “significant restraints” to the recovery.

Bernanke’s read of the economy is consistent with the results from the Fed’s latest Beige Book survey, which is based on anecdotal evidence of current economic conditions. The survey indicated that US economic activity had ‘increased somewhat’ since the beginning of March. Manufacturing improved across much of the country, while retailers reported that consumers were more confident about spending. However the report noted that the labour market remained weak.

Still, many believe that US share markets have got ahead of themselves.

Goldman Sachs recently released an interesting report that argued the recent run up in share prices means that the market is already fully discounting the positive earnings season.

According to Goldman, investors have latched onto the “better than expected” trend in earnings, and have been front running the last few earnings seasons. As a result, the recent earnings season have resulted in weaker share price performance as investors “sell the news”.

Goldman says that when the market floored in March 2009, investors were very negative about the earnings outlook. But companies were able to produce profits results that outstripped expectations. As a result, the share market surged 11% during the March 2009 earnings season, and by a very strong 15 per cent during the June 2009 earnings season.

By the time the September quarter earnings season rolled around, it was clear that corporate profit margins were expanding, and that as a result, companies were reporting better than expected earnings. Investors who picked up on this trend started front-running shares – buying stocks expecting that their share prices would rise when the companies subsequently announced results that exceeded expectations.

There was a strong run up in prices ahead of the September quarter results, but the share market rose by a very modest 1% during the actual earnings season. And the December quarter earnings seasons coincided with a 7% drop in equity markets – the biggest sell-off that we’ve seen this year.

Goldman notes that the rally going into the current earnings season is the largest we’ve seen since March 2009.

Although investors showed little propensity to ‘sell the news’ last night, it will be interesting to see whether they can sustain their enthusiasm throughout the entire earnings season.

This article first appeared on Business Spectator.