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Paying Attention to Earnings

Q1 earnings season is almost over. What does the little hype surrounding it mean for investors?

It’s no secret most economic news is backward-looking, but recent headlines seem to be taking that to a whole new level. Whether it’s the World Bank lowering its global growth estimate due to the US’s Q1 GDP contraction or a recent Commerce Department report on health care spending implying the dip will get revised down again, investors are surrounded by noise—noise that might make stocks’ coinciding rise seem unwarranted. Little-noticed is the one piece of Q1-related news that actually would provide a more investor-friendly snapshot of where the investible US private sector stands: Earnings and revenue growth, which continued in Q1.

If this made the front-page, it would probably catch folks by surprise. In April, at the outset of Q1 reporting, analysts estimated earnings would fall -1.4% y/y. They figured that chill Mother Nature threw at much of the US would sufficiently weigh on economic activity—to the degree that public companies would actually report shrinking earnings. This had some folks worried rising stock prices were detached from reality. But with only three firms left to report, Q1 earnings growth is +2.1%, with 74% of companies beating expectations. Sure, it’s a bit slower than Q4’s hot +8.5%, and it probably could’ve been better had the Northeastern US not temporarily returned to the ice age. But either way, it’s the 18th straight quarter of growth. Further, 7 of 10 sectors were up—broad-based!

But you can get rising profits even when macroeconomic conditions are pretty terrible. After all, firms could cut costs to get that result, which wouldn’t imply a healthy economy—just disciplined businesses. But that isn’t what happened in Q1. Revenues, a better gauge of private sector economic activity than GDP, also rose—and at a faster clip than profits. Revenues grew +2.7% y/y, with 9 out of 10 sectors in the black. Utilities led the way—not terribly surprising as many folks turned up the heat during the cold winter—but Health Care (+7.7%), Consumer Discretionary (+3.9%), Telecom (+3.6%) and Info Tech (+3.4%) all beat the average. All in all, positive revenue growth nearly across the board runs counter to the “weak economy” meme some in the punditry note.

But you’re not hearing much of any of this! Instead, headlines are shouting about a months-old fall in GDP. Perhaps these headlines do create some short-term market sway as investors initially digest the news. But in the long run, they don’t hold much weight for markets. Since GDP includes factors like government spending, net trade (exports less imports) and inventories (subject to interpretation based on other conditions), they don’t paint an accurate picture of 2014 as it pertains to stocks. You cannot buy a share of GDP. You can buy shares in publicly traded companies, and the earnings and revenue stats show they’re growing just fine.

Ultimately, completely ignoring GDP is a mistake. But investors should be wary about automatically drawing big (and long-term) conclusions from these data. In our view, it’s better to look under the hood and seek confirmation from pure private sector data. That’s where overall earnings and revenue data come in.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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