Earnings Season on Deck: Where to Put Your Money Now

This article was written with Oliver Pursche, co-portfolio manager of the GMG Defensive Beta Fund. It was part of a series of articles developed under an agreement with minyanville.com to work with a variety of contributors and assist them in delivering actionable investment ideas each week.

The utilities sector is expected to show earnings growth, while the tech sector is a mixed bag.

The first quarter of 2013 was one of the best first quarters on record, and the Dow Jones Industrial Average (INDEXDJX:.DJI) and S&P 500 (INDEXSP:.INX) both closed at new all-time highs. Corporate earnings, however, don’t appear to have fared quite as well. According to FactSet, year-over-year earnings growth will shrink by 0.7% in Q1, partially explaining why cyclical P/E ratios (according to recent research by Yale Economist Robert Shiller) now stand near all-time highs. So a bit of caution for investors is certainly advisable. Of course, as is always the case, there are pockets of both strength and weakness.

See the charts below for the first quarter of 2013 positive versus negative earnings pre-announcements so far.

Sectors Versus Stock Picks

The consumer discretionary and consumer staple sectors are expected to have some of the strongest earnings and revenue growth, and thereby the widest breadth, indicating that a broad sector bet may be the best way to invest here. Other areas of the market are likely to require more agility and stock picking skills than simple broad-based exposure. In the technology sector, Apple (NASDAQ:AAPL) is expected to see earnings shrink from $12.30 a year ago to $10.15 for Q1 2013. Of course, the stock has already been punished for this reversal of fortune.

In comparison, Microsoft (NASDAQ:MSFT) is expected to show a 28% increase in year-over-year earnings, something many analysts argue has not been priced into share prices. Income investors also need to be careful. Utilities, a traditional favorite among retirees, could prove challenging for investors. Although the sector is expected to show earnings growth, the sector’s growth is mostly concentrated in four companies: Duke Energy (NYSE:DUK), NRG Energy (NYSE:NRG), Northeast Utilities (NYSE:NU), and Edison International (NYSE:EIX). Lastly, from a sector basis, be wary of homebuilders. They did very well in Q1, but are seeing the highest level of earnings growth expectations of any sector in the S&P, making them most susceptible to disappointments.

The US, Europe, and Asia

The United States continues to be the most stable investment environment in the world (which is not to say that it will be the most rewarding). But, given strong gains so far, investors are increasingly looking for “alternative” places to invest. Risks in alternative assets such as emerging market bonds and other esoteric investments are plentiful. International equities, too, pose ongoing risks. Although the “worst” may have been averted with the Cyprus banking crisis, it is likely that there will be more troublesome headlines ahead. Small countries like Estonia and Latvia could prove dangerous new spots for the continent. More significantly, social unrest in Spain, Portugal, and other southern European nations could cause a run on their banks. This would likely create deeply felt and significant problems for the world’s banking system.

The other side of the world isn’t necessarily looking that much better. Most of Asia is slowing down with Chinese and Indian growth expectations down in the past few months. However, there is a potential bright spot in the region: Japan. The Nikkei (INDEXNIKKEI:NI225) ended the quarter with a 19% gain, largely as a result of the Bank of Japan’s recently announced asset purchases. Even after these strong gains, the Nikkei remains about 10% off its 2007 (pre-crisis) level highs. Aggressive growth-oriented investors may want to consider upping their exposure to this market.

The Bottom Line

It is unlikely that markets will suffer a deep or long-felt correction in the second quarter. However, a 6% to 10% pullback before resuming its upward trajectory is very likely, in my view. Investors are wise to review their portfolios and look for areas of the market that are exhibiting above average growth and ideally pay a solid dividend. Some of my favorites include Procter & Gamble (NYSE:PG) and Kellogg (NYSE:K) in the consumer staple sector, Microsoft and Cognizant Technologies (NASDAQ:CTSH) in the technology sector, and GlaxoSmithKline (NYSE:GSK) and Novartis (NYSE:NVS) in the pharmaceutical sector.

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