The Truth About Earnings

Posted On Jan 30, 2019 By Dave Gonigam

  • Apple masters the fine art of the “earnings beat”
  • Nomi Prins explains how they gamed earnings at Goldman Sachs
  • Smart money moving into oil: Knuckman’s two favorite names
  • Where’s the windfall from the corporate tax cut going?
  • Housing disappoints (again)… California rethinks its cannabis taxation… love-it-or-leave-it reader tells us to move to Venezuela… and more!

Live by the earnings reports, die by the earnings reports.

If you were with us on Monday you’ll recall the market fell hard because of unexpected bad numbers from Caterpillar and chipmaker Nvidia.

Today? As we write the Dow is up well over 1% — nearly 300 points — because of earnings reports from two of the index’s 30 component stocks.

Boeing is up 6.5% after beating the vaunted “analyst expectations” for the fourth quarter of 2018… and upgrading its outlook for 2019. BA figures on delivering some 900 commercial aircraft this year, up from 806 last year.

But the bigger driver of today’s rally is Apple.

“Tim Cook and co. know how to play Wall Street’s favorite game: Lower expectations and then beat the revised number,” quips our Greg Guenthner.

“Following a nasty 35% drop from its October highs, Apple has been stacking the deck for a slim earnings beat for the better part of the past two months. Management already softened the blow by cutting guidance weeks ago. The company also said it would stop reporting iPhone, iPad and Mac unit sales. That sleight of hand was all it took to get analysts and investors to focus on its growing services business and ignore the double-digit dip in iPhone demand.”

AAPL is up nearly 5%. At $162.23 the share price is now higher than it was when the company “guided lower” just after New Year’s Day. Well played, Mr. Cook.

“There’s always a game when it comes to earnings,” says our Nomi Prins. And she would know, from her days working for the vampire squid.

“Wall Street analysts always tend to downplay their expectations of corporate earnings going into reporting periods. That because corporations downplay them to analysts. It’s Wall Street’s way of gaming the system.

“When I was a managing director at Goldman Sachs, senior members of the firm would gather together each quarter with the chairman and CEO of the firm, Hank Paulson, who went on to become the Treasury secretary of the United States under President George W. Bush.

“He would talk with us about the overall state of the firm, and then the earnings figures would be discussed by the chief financial officer.

“This would be just before our results were publicly disclosed to the markets. There was always internal competition amongst the big investment banks as to what language was being provided to external analysts about earnings and how the results ultimately compared with that language.

“You couldn’t be too far off between ‘managing expectations’ of the market and results of the earnings statements.

“However,” Nomi goes on — and this is crucial — “there was a large gray area in between that was exploited each quarter.

“When I was there, it was very important for Goldman to have better results than immediate competitors at the time like Morgan Stanley, Merrill Lynch or Lehman Bros.

“It was crucial to ‘beat’ analysts’ expectations. That provided the greatest chance of the share price rallying after earnings were released.

“The bulk of our Wall Street compensation was paid in annual bonuses, not salaries. These bonuses were in turn paid out in options linked to share prices. That’s why having prices rise after fourth-quarter earnings was especially important in shaping the year’s final bonus numbers.”

So that’s the game corporate America plays with earnings. “Investors that don’t know this tend to get earnings season all wrong,” Nomi concludes. “However, successful investors that take forecasts with a grain of salt will do better.”

Pity anyone who was shorting Apple this morning, huh?

[Ed. note: In addition to earnings season, Nomi is keeping a keen eye on the Federal Reserve — which will have issued its every-six-weeks policy statement by the time you read this; we’ll follow up tomorrow.

In the meantime, the Fed has already made a significant move that’s set to rock markets less than 24 hours from now. Click below for a brief video message Nomi recorded in front of Fed HQ in Washington…]


press play

Crude prices are once again flirting with highs last seen about two months ago. A barrel of West Texas Intermediate fetches $54.39.

“I’m seeing some major moves in the energy sector,” says our Zach Scheidt. “S&P 500 energy company fourth-quarter earnings are expected to grow by a whopping 73%, according to FactSet.

“Energy stocks fell 1.5% last week, but they’re up 17% in the last month. In fact, energy represents the second-best performing S&P sector, beaten out only by consumer discretionary stocks.

“And make no mistake, the smart money is positioning for a rebound in the oil patch,” Zach goes on.

“Franklin Resources purchased 24 million shares of shale oil driller Goodrich Petroleum Corp. (GDP) last week. The fund increased their holdings of GDP by an eye-popping 900% — and it now owns 22% of total shares outstanding.

“Oppenheimer Funds, which manages $223 billion in assets, bought 7 million shares of six different energy companies last week.

“The fund’s biggest buy was a 1.8 million purchase of oil-and-gas services company CSI Compressco (CCLP), increasing their position by 48%.”

“Energy stocks are positioned to pop this earnings season on rising energy prices,” affirms Alan Knuckman from his perch in the Chicago options trading pits.

He has two favorite names right now, starting with Brazil’s state-owned oil giant Petrobras.

PBR has spanked the broad market this month, jumping 12% to nearly $16. “But despite the recent rise in price,” says Alan, “analysts at Bradesco and Morgan Stanley are maintaining price targets north of $20.” PBR reports earnings on Feb. 28.

Closer to home, Alan likes the pipeline player Energy Transfer. “ET charges a toll on the volume of oil that passes through its pipe,” Alan explains. “And because American oil companies are producing and transporting oil at a record pace, ET profits no matter what oil’s price is.”

ET is also up big this month… but Alan says don’t be shocked if shares jump another 50% from here.

Gold is holding firm above the $1,300 level — $1,311 as we check our screens.

For the record: The windfall from the corporate tax cut is not translating into companies investing in the future growth of their businesses.

Every quarter, the National Association for Business Economics conducts a survey of corporate America. The latest one is out this week, and NABE president Kevin Swift says the takeaway is unmistakable…

“A large majority of respondents, 84%, indicate that one year after its passage, the corporate tax reform has not caused their firms to change hiring or investment plans.”

What are companies doing with the money instead? We saw it coming nearly a year ago — dividends and buybacks, mergers and acquisitions. Corporate CEOs are no fools — they know we’re in the late boom phase of the boom-bust cycle and it’s a lousy time to expand.

Speaking of which, we got another miserable housing number this morning.

Pending home sales as calculated by the National Association of Realtors tumbled 2.2% during December — way more than the “expert consensus” was counting on. And that’s despite mortgage rates pulling back from their recent highs.

“The pending sales index can be volatile,” sums up Econoday, “but the direction of today’s indication is unmistakable.”

California lawmakers are starting to recognize that when it comes to cannabis legalization, they’re doing it wrong.

It turns out that a year after recreational weed became legal, legal cannabis sales have fallen… because Sacramento is so greedy for revenue. Meanwhile, the black market thrives.

We anticipated this problem in the spring of 2017, months before legalization. Not only did legislators enact a 15% sales tax, but there’s also a flat $9.25 per ounce tax on flowers and $2.75 per ounce on leaves — no matter the market price!

From the Department of Better Late Than Never, Assemblyman Rob Bonta (D-Oakland) has introduced a bill trimming the sales tax from 15% to 11% and eliminating the flat tax on flowers and leaves.

Well, at least through mid-2022. Then the tax rates revert to present levels. But even Bonta recognizes that the present scheme doesn’t work if the aim is to “protect legitimate taxpaying businesses and stop the illegal black market in California,” as he told reporters yesterday.

Gee, ya think?

“If you believe the U.S. is in decline you should move to Venezuela and help them work it out,” a reader writes after we questioned the wisdom of Washington’s latest regime-change efforts.

“Of course, it may be difficult when all you unarmed revolutionaries are facing the serious weapons from the socialist dictatorship of Bolshevik President Maduro.

“Please leave for that country right away, and do let us know how working it out amongst themselves goes.

“Ignorance is bliss, Dave.”

The 5: OK, we take it all back. We’re sure Trump’s intervention against Maduro in Venezuela will work out at least as well as Obama’s intervention against Gaddafi in Libya in 2011.

Oh, wait…

Back in the real world, events took an alarming new turn yesterday. “The State Department certified that [opposition leader Juan] Guaidó has authority to control all Venezuelan government bank accounts in the U.S. financial system, giving him access to any cash or gold Venezuela may be holding in U.S. banks,” reports the McClatchy newspaper chain.

The day before, Washington froze the U.S.-based assets of PDVSA, the Venezuelan state-owned oil company.

Put yourself in the shoes of a foreign CEO whose company has substantial U.S. assets. You’ve got to be wondering how safe those assets truly are if someone in D.C. — whether this administration or the next one — gets a burr up his saddle about the government of your home country. At the very least, it makes you leery about building a new factory or otherwise expanding your U.S. operations.

Whelp, that’s how it goes when Washington presumes to be, in the words of France’s finance minister last year, “the economic policeman of the planet.” Karma’s a female dog…

“I find it hard to believe anyone really believes that call was ‘blown,’” a reader writes after we took exception to a congresscritter’s intentions to make a federal case out of the New Orleans Saints’ loss in the NFC championship.

“Everyone that was watching knew it was pass interference. It was impossible to miss THAT! Helmet to helmet, maybe, I did not notice that. The refs clearly ‘looked the other way.’

“Someone wrote an article that I read two or three days prior to the game that the network that was televising the Super Bowl ‘preferred’ the Rams and Patriots matchup for the big one. I saw several calls in both games that looked really fishy and went in favor of the Pats and the Rams. The games were rigged. Period. Is there a law against that? Can’t the NFL rig ’em if they want?

“CBS is paying over $1 billion for the package that includes the Super Bowl. With that kind of cash I can assure you they have some pull on what they will get. And now that the world knows the commissioner of the NFL has the power to do anything he wants to make it right and is choosing to do NOTHING, what more evidence do you need?

“NASCAR manipulates the races all the time with questionable yellows and nonyellows when clearly a yellow should come out. Wherever there is money there are crooks nearby!”

The 5: Conspiratorial, aren’t we?

But you raise an interesting point. TV executives have wrung their hands about “small market” teams getting into “big games” since — at least — the 1985 World Series between St. Louis and Kansas City.

Speaking of Kansas City, I’d have been really jazzed to watch Patrick Mahomes in the Super Bowl. Shady Brady? Been there, done that. My wife and I are making plans for this Sunday, and football isn’t a part of them…

Best regards,

David Gonigam

Dave Gonigam
The 5 Min. Forecast

P.S. Once again, we’ll follow up tomorrow with anything important from the Federal Reserve’s every-six-weeks meeting this afternoon.

But there’s another development at the Fed that could have a far more dramatic impact on the markets… and, if you choose to act, your portfolio. Click here for this urgent update from our Nomi Prins at Fed headquarters.


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