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Buy or Sell the "Sell the News" on Intel?


Or, do nothing.

I think it's probably too early to make much of the "sell the news" reaction to Intel's (INTC) blowout earnings report. But it's not too early to start putting it in some sort of analytical context.

On the one hand, given that it's hard to imagine a much better earnings report than the one Intel just provided, the market response to such news is worrisome.

On the other hand, if the very strong Intel results are representative of what's happening in the tech industry (and they very often are), many more positive surprises will be coming down the pipeline, and such a prospect is quite bullish for the market. Readers may recall that there were various "sell the news" reactions early in 2009's third-quarter earnings reporting period (particularly in financials), yet the steady stream of "beats" later in the earnings period eventually overcame this early tendency and the market went on to rally strongly.

Will the pattern of the third quarter of 2009 repeat? The answer to this question is important because the vast majority of the upside since this rally began in March 2009 has occurred during and around earnings season in response to better-than-expected earnings releases. Relatively little upside was achieved during the "dead" periods.

In this regard, as I pointed out in Quietly, A Top Seems to be Forming, there are various early signs that earnings expectations may have caught up to the improving reality. If such early signs prove to be prescient, true "beats" should be harder to come by.

Under a scenario in which earnings reports are no longer driving stocks, the market as a whole should tend to become more dependent on macro data. And with this in mind, I'd point readers to my article Bi-Polar Economic Data?, in which I argued that the economic data will likely remain contradictory for a while -- as it always does in the very early phases of an economic recovery.

A peaking of the second derivative trend in earnings expectations combined with macro data that is contradictory will tend to support my prediction of a market topping process and entry into a sideways consolidation, or trading range. This prospect was discussed in, Are We Headed Toward a Range-Bound Market?

Now, back to the central question this article poses: Will the pattern of the third quarter of 2009 reporting period repeat whereby massively positive earnings beats and revisions are able to overwhelm the "sell the news" tendency?

As far as the technology sector is concerned my answer is "probably". However, positive technology results alone may not be enough to carry the entire market, and as I pointed out in my last piece, I think that the situation for cyclicals and financials may prove to be less favorable. Thus, taking into account the totality of the market, and based on what I've seen thus far (it is still early days), I wouldn't necessarily expect a general market ramp based on results from the fourth quarter of 2009 earnings period.

How about shorting based on the aforementioned hypothesis that a topping out of earnings expectations may coincide with a top in general stock prices? I don't think the reward-risk equation is favorable enough at this point.

First of all, the hypothesis that earnings expectations may be topping needs further empirical support.

Second, overall cash levels are still too high. Thus, technically speaking, shorts will be very vulnerable to significant upward thrusts if earnings relative to expectations (particularly in financials and cyclicals) are more robust than I'm currently suspecting.

Thus, I'm doing nothing.

Note to readers: If such an analysis and strategy strikes you as lame and/or frustrates you, please consider Why Investors Will Almost Never Make It Big.
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No positions in stocks mentioned.
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