BOSTON (TheStreet) -- Mutual fund managers are turning to Google (GOOG) - Get Report and Delta Airlines (DAL) - Get Report to make money before companies report second-quarter results, which may show that profit growth is slowing.
Still, corporate earnings kept rising, even as unemployment remains high and consumers curb spending. Standard & Poor's estimates that S&P 500 companies will see operating earnings per share climb to $23.85 from $22.60 in the first quarter and $20.90 a year earlier. Aluminum giant and
unofficially kicks off the earnings season when it reports financial results after the market closes July 11.
Google says that it is not surprised by Microsoft's move to embroil the search giant in a deepening EU antitrust battle.
However, a rash of dour pre-announcements from companies has brought a lot of uncertainty to a market already contending with fears of a global economic slowdown and worries over debt-laden European countries like Greece and Portugal. On Tuesday, Moody's cut Portugal's credit rating to junk status on the growing risk that the country will require additional bailouts. That came not long after Greece voted to implement austerity measures to bring its own debt under control.
LPL Financial chief market strategist and
contributor Jeff Kleintop noted last week that the ratio of negative-to-positive pre-announcements is 2.3, above the historical average pre-announcement ratio of 2.1. He argues that the above-average ratio often lowers the bar on analyst expectations heading into the heart of earnings season, as investors price in a greater probability companies will miss earnings estimates.
have already made negative pre-announcements, lowering their outlook for the second quarter. Even so, many mutual fund managers remain bullish in the face of the flood of earnings reports.
"The markets are fine," says Jerry Jordan, manager of the Boston-based
Jordan Opportunity Fund
. "We've got a market that has record earnings -- record earnings on S&P 500. Historically, when you first move to a new high in earnings, you almost have no risk whatsoever of an economic decline. You're just starting to get into that self-reinforcing cycle."
Jordan notes that the price-to-earnings multiple of the S&P 500 is around 12.5 times estimates for 2012, which he says is "just not expensive. Historically, you'd need interest rates at 6% to 7% to be nervous about the valuation of the market. After the recent rally, rates are only at 3.5%. I don't think we have a lot of risk, although we don't have a lot of return. It's really a stock picker's market."
Mark Schultz, manager of the Baltimore-based
MTB Mid-Cap Growth Fund
, is similarly positive on the market but for different reasons. He argues that investors are too pessimistic, even with the 650-point increase on the Dow Jones Industrial Average last week.
"The market has been fixated on things like the Greek sovereign debt, and there have been reduced expectations reflected in share prices," Schultz says. "It's been so much so that a lot of pressure has been taken off of earnings. The pessimism in the market sets up for the same thing we saw a year ago, when there was double-dip hysteria gripping the Street before earnings came through quite strong."
While he notes that this year's pessimism heading into second-quarter earnings isn't as extreme as it was in 2010, Schultz says he expects "the same type of dynamic will unfold," where the S&P 500 rallied 8% in July 2010 on earnings results.
Schultz, Jordan and Brian Frank, manager of the
Frank Value Fund
, offer the
in their portfolios ahead of the earnings rush, which are detailed on the following pages.
Jerry Jordan has been a big fan of consumer discretionary, particularly ones that have struggled with high raw material prices or high energy prices. These are a double-edged sword for many companies, as it affects their own cost of goods sold as well as the ability of their customers to buy products.
Jordan, who won big recently on bullish bets on media stocks like
( VIA-B) and
, says he has had a tough year after the February high because of his new focus on the consumer.
"Honestly, if you said to people that there is a manager who loves the consumer, everyone on the planet would think you were nuts," he says. "Why would you ever like the consumer? The consumer has re-liquefied. Most consumer companies have re-liquefied. The stock market has seen a big run, interest rates are low, gas prices are coming down. They've got money to spend again."
With his focus on consumer discretionary, one of the stocks Jordan likes is apparel maker
, which is down 9% in 2011. Jordan says now is the time to buy Guess as the company appears to be in the final stages of its turnaround. He likens to company to watchmaker
, which rallied from $30 a year ago to $120.
"Guess appears to be finally turning the corner with comps, earnings and revenue," Jordan says. "They worked down their inventories globally. I think they're in front of a fashion cycle that is working for them. The comps are reaccelerating. Guess is an interesting stock because it's cheap and has a fashion aspect that could be global. That's the key driver."
In terms of earnings, Jordan notes that in the previous quarter, while earnings were down year-over-year, Guess beat expectations by 25%. "So here's a stock that's 12 times earnings that is beating by 25%. When you beat a quarter by 25%, that's usually a good sign that you have a turn coming," Jordan adds.
Away from apparel, Jordan says he believes we are on the cusp of the end of the commodity bull market in industrial commodities. While agriculture could potentially double, he says, oil prices have seen their high. "I'm not saying oil is going back to $40, but I think things on the margin will keep a lid on oil," Jordan says. "Supply is slowly working its way in and there is a lot of substitution. Essentially, the game is over in oil."
Jordan says now is the time to start thinking secularly about the anti-commodity, anti-industrial trade. If oil prices have indeed peaked and the U.S. economy is in good shape, Jordan says that
and other airlines could be big winners. For the first time, these companies are managing for profitability, not market share, Jordan says.
"All the airlines look interesting to me here," he says. "They've been unbelievably efficient. They've been unbelievably diligent. Every time oil pops up, they ground planes and yank them out of the fleet in order to stay as profitable as possible. I think they'll be slow to bring those planes back."
Specific to Delta, he argues the company could earn a "boatload more money than expected" with flat oil prices. "Instead of earning $2 in 2012, it could be $4. The swings could be wild, so it's tough to find the right multiple. If things turn the right way for them, it gets really interesting," he says.
Brian Frank, manager of the
Frank Value Fund
, says the valuation of his portfolio is the cheapest he has ever seen headed into second-quarter earnings, and that includes 2008 and 2009 when share prices plummeted during the heart of the deep recession.
Frank's fund finished the second quarter up 14% and the portfolio still remains cheaper in July than it was at the beginning of the year. Even with a concentrated portfolio, Frank says earnings season can be frentic as a fund manager.
"We hold 33 positions, so that's 33 conference calls and 33 releases we're looking at as soon as they come out," Frank says. "We read the statement, we glance at analyst estimates for reaction, and we update our numerical models on every company. Most of the time, we'll listen to management's conference call. It is pretty intense around earnings season."
One company he will be paying close attention to is
as the stock has already more than doubled this year and has also found a fan in Steven Cohen, manager of the hedge fund SAC Capital. Frank bought Weight Watchers when the stock traded around $20, and while he notes it doesn't look like a great value pick any longer, there is still room to run.
"I've never seen operations accelerate before like I have in Weight Watchers," Frank says. "They're growing the business at an incredible rate without spending any money. The expectations may actually now be low, but with operations acceleration, it usually continues for a few quarters. We think they could surprise and some of the momentum could come back into the stock."
Frank expects a similar surprise out of
, which is looking to put a disastrous first-quarter conference call behind it. "Larry Page didn't make any friends in the first quarter," Frank says, referring to the Google co-founder who took over as CEO earlier this year. "He came on the call for two or three minutes, he said a few cryptic things, he didn't take any questions, and then he left."
While most market participants may continue to focus on both Page and the new technology rollouts by Google, including the Google Chromebook and Android mobile operating system, Frank says investors would be smart to focus instead on what the company says about advertising. Google shares are down 10% this year, vastly underperforming the broader market.
"Google has all this neat technology, but Google is an advertising company," Frank says. "They really generate revenue by people clicking on ads when they do a Google search. That growth was tremendous in the first quarter. Not only are more people doing searches through Google, but the average price on those AdWords is going up. Traditionally, it's great to come out of the recession with an advertising company."
Staying in technology, Frank is also bullish on
, which has become a traditional value stock as the consumer PC market soured. Frank says Dell is also widely misunderstood, noting that consumer PC sales make up only 2% of Dell's operating income.
"It's a very misunderstood company because you still hear it referred to as Dell Computer, and it actually changed the name to Dell Inc. They're not so much about the consumer PC," Frank says. "The vast majority of it is business PCs, servers and services. They're now doing consulting, installation and maintenance. With the emergence of cloud computing, there is a lot of back-end work to be done, which is what Dell is getting into. That's high margin stuff."
Frank also highlights Dell's commitment to buy back over 10% of the company this year as well as insider buying by founder and CEO Michael Dell. "When the insider buys, they think their company is undervalued. Anyone can have a reason to sell, but there's only one reason to buy," Frank adds.
Mark Schultz, manager of the Baltimore-based
MTB Mid-Cap Growth Fund
, shrugs off the importance of earnings season when it comes to finding attractive investments.
"Quarterly earnings are fun, and they make for a lot of excitement, but at the end of the day we're looking for business models and franchises that are in position to deliver long-term value for shareholders," Schultz says. Currently, he is upbeat on consumer discretionary, industrials, and technology.
Among industrials, Schultz says his top picks are mining equipment maker
( JOYG) and engine maker
"Relative to what's implied in the share price, I would expect good things due to global demand and improving U.S. demand," Schultz says of Joy Global and Cummins. "We've been holding both of these stocks for years in the fund, through good quarters and bad quarters, and they've been successful investments because they have compelling business models. I do expect good quarters, but that's not why we own them or any other stock."
Among technology companies, Schultz says he likes
, which has dropped more than 20% this year as many semiconductor companies have come under pressure on demand fears. "There is a great deal of pessimism around this space," Schultz says. "Broadcom has had a tough year but it's well positioned thanks to the wireless technology area."
It's Schultz's pick in the consumer discretionary space that is most interesting.
has rallied 225% over the past 12 months, but Schultz still sees plenty of upside in the designer and retailer of yoga apparel.
"Obviously, with investing being forward-looking, it was easier at $4 per share in 2009 than $113 now to find considerable upside," Schultz says. But he argues that there is no evidence that demand for their product is attenuating.
"It has a very compelling business model with good store-level economics," he says. "It can see more square-footage growth, which is hard to come by. We're a long way away from saturation, which is the death of every retail concept. Very tight inventory control, very good cash. The online presence needs to grow, which can lead to high returns."
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-- Written by Robert Holmes in Boston
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