Sunday, August 16, 2009

Has The Recession Ended?

Has the recession ended? Any truly honest person will tell you, your guess is as good as mine. However, now that second quarter earnings season is coming to a close, it's time to reflect on the first half of the year and what we might see in the second half.

In the first half of the year, around 77 % of S&P 500 companies beat consensus earnings forecasts for the second quarter by an average margin of 11 percent. This suggests that the earnings revisions cycle has finally bottomed for most sectors. The revision cycle is straightforward: In the early stages of an economic (and profit) recession, analysts tend to hold their estimates too high; companies routinely disappoint as they simply can’t meet still-lofty expectations in the face of economic headwinds. By the time analysts get around to revising estimates to more accurately estimate earnings, most companies have already cut their costs to the bone and we tend to see a majority coming in above earnings estimates.

Since this is what happened at the end of the second quarter, what can we expect to see for the remainder of 2009? The simple answer is that rising earnings estimates tend to drive stock prices higher. The bottoming of the revision cycle will be a key upside catalyst for the broader averages through the end of the year. While it’s clear that if the recovery is to be sustainable, we need to see actual revenue growth, aggressive cost cutting during the past year by US corporations leaves them with a great deal of earnings leverage. Which means with any recovery in final demand, they should be able to post some truly impressive year-over-year growth numbers as we head into the latter months of 2009.

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