Why Analysts And The Fed Are In Uncharted Territory (And How I’m Trading)

According to FactSet, we are more than halfway through earnings season. About 59% of the companies in the S&P 500 have reported results for the second quarter. Results are better than expected.

How much better, you ask?

Of those companies that have reported, the vast majority (88%) have reported earnings per share (EPS) that beat analysts’ expectations. In a typical quarter, about 75% of earnings reports are better than expected.

And we’re not talking about outperforming expectations by just a little bit. Companies are reporting EPS that are an average of 17.2% above estimates, which is well above the five-year average of 7.8%.

Companies are also reporting better-than-expected gains in revenue. Again, 88% of companies that have reported have beaten expectations for revenue. Over the past five years, only 65% of companies normally beat revenue expectations.

On average, sales have been 4.5% higher than estimates, more than triple the five-year average revenue beat of 1.2%.

Looking at the numbers, one question comes to mind — why have analysts suddenly gotten so bad at estimating earnings?

Of course, their skill level hasn’t actually changed. They are dealing with an unprecedented recovery after an unprecedented decline in earnings. They’re doing their best, but their models aren’t calibrated for such unusual times.

So, instead of trying to adjust, most analysts are sticking with their models and expect earnings season to be normal again soon. By 2022, they expect EPS growth to be back in the single digits.

The Fed’s Projection Game

The Federal Reserve also relies on models, although unlike the analysts, officials seem to be tweaking their models to achieve desired results rather than relying on strategies that worked well for decades.

After last week’s policy-setting meeting, Chair Jerome Powell said, “Our approach here has been to be as transparent as we can. We have not reached substantial further progress yet. We see ourselves having some ground to cover to get there.”

According to CNBC

“Substantial further progress” on inflation and employment is the benchmark the Fed has set before it will tighten policy, which would mean slowing and ultimately stopping monthly bond purchases and ultimately raising interest rates. The statement noted only that “progress” has been made, and the FOMC will continue to watch conditions to see how close they get to the Fed’s goals.

This could be an ineffective approach to policy. The Fed seems to be targeting fuzzy goals like “substantial further progress” which is difficult to understand. By some measures it appears the economy has made substantial progress.

The chart below shows that GDP has recovered from its pandemic-induced dip.

Source: The New York Times

The New York Times noted…

The U.S. economy climbed out of its pandemic-induced hole in the spring as vaccinations and federal aid fueled a surge in consumer spending at restaurants, resorts and retail stores.

The revival brought gross domestic product back to its pre-pandemic level in the second quarter, adjusted for inflation — a remarkable achievement, exactly a year after the economy’s worst quarterly contraction on record. After the last recession ended in 2009, the G.D.P. took two years to rebound fully.

I look at the Fed’s position and wonder how to reconcile it with data. It would be nice if Richard Fisher were still with the Fed so he could remind the decision makers of something he said in 2012

From my present perspective on the side of the angels, as a member of the policymaking team on the FOMC, I believe adding to the accommodative doses we have applied rather than beginning to wean the patient might be the equivalent of medical malpractice. Having never before pursued this course of healing, we run the risk of painting ourselves further into a corner from which we do not know the costs of exiting. It is my opinion that we should run that risk only in the most dire of circumstances, and I presently do not see those circumstances obtaining.

How I’m Trading Right Now

Like Fisher, I believe the Fed is creating risks, and that is likely to end badly. The truth is, just like analysts are missing their targets right now, the Fed doesn’t really know how this will all pan out. But that’s a long-term concern.

In the short run, there are reasons to be bullish. So there’s no reason why we can’t make some profitable trades in the meantime…

My Income Trader Volatility (ITV) indicator turned bullish last week, as shown in the bottom panel of the SPDR S&P 500 ETF (NYSE: SPY) chart below.

My ITV indicator ITV is similar to VIX in that it rises as prices fall. Its current position, with the ITV indicator (red) just below its moving average (blue), points to potential strength in stocks.

Our last chart this week shows my Profit Amplifier Momentum (PAM), which could confirm the “buy” signal this week.

PAM is designed as a short-term indicator. The red bars are bearish, and the green bars are bullish. Its recent uptrend (marked by the change from red bars to green) is a potential indicator of strength.

An “up” move appears to be the most likely trend in the short term, for now. And that’s good news for us, because my team and I have just exposed a legal “loophole” that anyone can start using TODAY to collect on-demand income – in as little as 6 minutes…

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