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Sozzi's Day Ahead: Steer Clear for Now

Seriously, guys and gals -- no joking -- what in the world is happening in the markets right under our very noses? In the past couple weeks, I have gotten the drift on a range of topics.

  • Go forth and buy tech, kind sir or madam. It will be a relative earnings outperformer for the third quarter and, boom, right into year-end. These are companies that generally offer a high rate of earnings growth and have cash positions to fund research in the next gadget that will drive future profits in 2015 (Caterpillar (CAT) meets tech, I suppose).
  • For companies sporting attractive dividend payouts, give a wink, nod, and a great big smash on the iMac mouse pad. As these names are sitting on mounds and mounds and mounds of cash, moreover, these dividends could hiked yet further. Of course, if you peak into the 10-Q SEC filings, you'll see most of that cash is tied up in overseas accounts or is earmarked for international investment.
  • There is this imaginary, magic pile of sideline money just itching to juice stock valuations on decelerating profit margin expansion. When I hear comments like these, after I finish cringing I immediately switch gears to the voice of Alec Baldwin in this epic Glengarry Glen Ross moment.
  • Early-inning earnings warnings -- yeah, those are irrelevant as earnings estimates. The real stars of the season are so low that even the slightest beat will lure in the aforementioned imaginary pile of money into the mix.

I pen this missive in the mindset of an animal -- a caged, wild animal shaking the bars. Since the Fed's announcement of a third round of quantitative easing, not a day has gone by when we've lacked an abundance of in-your-face developments making a strong counter-argument that there will be a better entry point for stocks a little further into the future. Last week, I highlighted that we should watch revenue quality, and now that is quietly being discussed en masse.

In other words, to me it appears the market is looking for reasons to sell news. Along this line of thought, remember that Apple (AAPL) is not the entire tech sector. Repeat: Apple is not the entire tech sector. It may be selling the best darn products on Mother Earth not found at Whole Foods (WFM) and GNC (GNC), but the stock pullbacks I am watching outside of the Steve Jobs-laid ecosystem are indicative of systemic economic issues both abroad and here at home. For instance, in my view, trading in stocks such as eBay (EBAY) or an IBM (IBM) is raising flags that consumer spending could be starting to reflect fiscal cliff concerns, while business spending could be impacted by volatile stock prices post-Fed. The market moves first, and the jacked-up consumer-confidence reports follow.

If I am hyping you up, good -- that is the target objective. I say now is not the moment to get long to the extent that the talking heads are yelling. In order to get to that moment, let's first put a few earnings reports under our belts, and then chart the course to winning into year-end.

As for what I am seeing and sensing right now, here you have it.

  • The recipe for an earnings miss is a surprise revenue shortfall that's not matched by compensating adjustments to costs and expenses -- and the Street falling asleep on this. We have witnessed not only earnings warnings from the majority thus far, but massive misses compared to "low hurdle rate" earnings estimates. (As for Alcoa (AA), production was cut, and I will be bold and say it's a revenue warning.)

    Could this continue? Umm, why not? You mean to tell me that we are unable to extrapolate anything from FedEx (FDX) and Norfolk Southern (NSC) and apply it to next week's scheduled report from McDonald's (MCD), on which I'm still negative? We could say the same thing about an industrial of our choice -- though not General Electric (GE), as it may have pricing power. Let's take a further step into the madness. Do we have full, unyielding trust in 2013 estimates, given growth concerns for the first half of the year? Note that earnings targets for next year have been trimmed by an average of $0.05 for S&P 500-tracked companies from the beginning of the year, or so noted a research note that I snagged.

  • Profit margins staying at high levels is not the same as profit margins expanding to a new level. If profit margins hover around a certain level, it's usually because a company has no other place to cut expenses on weak volume, or because it's yearning for some semblance of pricing power in total revenue. Are you willing to assign a richer multiple to that scenario? The market is asking you to do just that.
  • The market has pummeled companies that have warned. Why not wait to be proven wrong on the idea that this trend has a shot of reversing?

For the time being, I sit on the assorted long ideas I have divulged of late, and I continue to build the list of potential near-term horror stores (for instance, Boston Beer (SAM), as I discuss in this video).

Bucket Shop Rumor Mill

  • Activision Blizzard (ATVI) stock price says: Call of Duty is competing for holiday season eyeballs more so than the norm. Also, I am not enamored with the subscriber trends at World of Warcraft. Avoid this name.
  • ADP (ADP) has given back its gains post-September employment report (watch G&K Services (GKSR)).
  • Starbucks (SBUX) is below its 50-day moving average, so stay clear of this one for now as well. In going back to the second-quarter earnings call, now, I am not so sure the turn in the European business accelerated sequentially. Also, I was burnt on the last earnings report, and will not be fooled again.

At the time of publication, Sozzi had no positions in the stocks mentioned, although positions may change at any time.

Brian Sozzi is Chief Equities Analyst for NBG Productions. In this capacity, he is responsible for developing independent financial content and actionable stock recommendations (including ratings and price targets) for an institutional and retail investor base. In addition, Sozzi is the Editor in Chief of the "Decoding Wall St." investor education online platform.

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