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My friend Chris had just hit another golf ball out of bounds. Only this time, it sailed into the adjacent fairway and nearly took the head off some guy lining up his pitch shot.
Chris was NOT a good golfer. In fact, he was undeniably the worst player in our group last spring.
And yet, despite hitting every other shot off-course, Chris still managed to beat me, my brothers, and our other friends at our informal golf tournament.
How did he do it?
It all ties back to a handicapping system that gave Chris an unfair advantage.
Fortunately for you, there’s a similar system in the market right now, setting up some big gains for investors who are paying attention.
Let me explain…
Leveling the Playing Field with a Weak Handicap
Chris was able to win the tournament because his golf “handicap” gave him a number of free strokes. If you’re familiar with the handicapping system, you know that scores from previous rounds are added up to reach an appropriate number of free strokes.
The only problem is, people can intentionally write down poor scores ahead of a tournament, to set the bar low. Then, with more free strokes, it’s easier to beat the competition. Most players call this “sandbagging” and it’s definitely an unfair way to win.
I’m not saying that’s what Chris did. But you never know!
Chris’ victory comes to mind as I look through first quarter earnings that have been driving stock prices for the past few weeks.
You see, corporate executives have been sandbagging in their own special way, telling investors to expect weaker earnings through the rest of the year. But if you look carefully at what’s going on behind the scenes, a different story emerges.
As report for fourth quarter earnings roll in, the average S&P 500 company has increased profits by about 28%. That’s a healthy rate of growth, and a big part of the reason stocks have been trading higher this year.
But there’s one problem with earnings season this month. Executives have been telling investors to expect weaker profits for the rest of the year. According to Bespoke Investment Group, the guidance numbers for this quarter are some of the weakest over the last 15+ years!
What’s driving this poor outlook?
Well, corporate executives have a number of concerns that are causing them to be more cautious when telling investors what to expect.
For starters, last year’s profits grew sharply because of the recent corporate tax cut. This year, companies will still enjoy lower tax rates, but they’re not going to change from last year. So we won’t get the same kind of growth seen in 2018.
Second, the government shutdown has been a big issue as these executives put together their talking points. With so much uncertainty (and potential fallout with millions of Americans missing paychecks), it makes sense for companies to be a little cautious moving forward.
Finally, the trade war with China may be on hold, but it’s not solved yet. We’re still waiting to see whether the U.S. and China will be able to hammer out a deal. And that deal could have an impact on how different companies generate profits this year.
Add it all up, and you can see why executives are managing investor expectations. They certainly don’t want to wind up with a weak report later in the year that misses expectations and sends their company’s stock plummeting.
The Evidence Says Something Different
While I don’t necessarily blame managers for being cautious with their guidance, the evidence that I’m seeing right now points to a much stronger environment for stocks this year.
For instance, sales growth has been rising at the fastest level in several years. Keep in mind, sales numbers aren’t directly affected by the corporate tax cuts. So this gives us a more accurate picture of how the economy is growing and how consumers are spending money.
And that picture is very strong!
Corporate spending is also picking up.
Recent reports from the mighty Facebook, Amazon, Netflix and Google corporations have been increasing capital expenditures to grow their businesses.
And this year, that spending will continue to grow.
Google’s chief financial officer Ruth Porat noted that the company will undergo an uptick in purchases of servers and other equipment. Facebook will spend an extra $4 billion to $6 billion more than last year’s $14 billion on growth opportunities. And Amazon will be spending more this year to build out its AWS cloud service business.
All of this spending will help companies that supply key products and services for growth projects. And these suppliers will need to hire workers driving strong employment, healthy consumer spending, and overall economic growth.
In other words, despite the cautious guidance from corporations this year, the overall economy is strong and profits should continue to grow.
That leaves us with an interesting situation…
The Bar is Low, So the Future is Bright
With corporations encouraging caution, and the economy exuding strength, something’s gotta give this year.
Think about what is going to happen in the second and third quarters when companies continue to grow profits and the economy keeps on trucking. What about when a new government spending bill is reached? Or what happens if we reach an agreement with China?
At this point, investor expectations are fairly low. Much like our expectations for my friend Chris’ golf game.
With the bar set so low, it won’t take much for companies to perform better than expectations.
Investors with cash on the sidelines will scramble to get more of their capital in play.
And as their buy orders hit the market, stocks will naturally rise.
Of course, here at The Daily Edge, we’ll continue to highlight the stocks with the biggest chance of beating investor expectations and trading sharply higher. But you need to make sure you’re locking in your investments ahead of time, before prices start moving higher.
Don’t be misled by the sandbagging corporate executives!
Here’s to growing and protecting your wealth!
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