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Michael Fowlkes' Analyst Insights

InvestorsObserver
Options and ETF Analyst Writer
Michael Fowlkes
Author Bio


August 19, 2013 - Summer Earnings Season Winds Down Optimistically

The summer 2013 earnings season is coming to a close, and thus far we have seen mostly positive reports.

Not only have earnings generally been on the positive side, but more companies are reporting better than expected numbers than historically do. According to S&P, over the last ten years 62% of companies in the S&P 500 report earnings that are better than analysts forecast. Of the first 438 companies in the S&P 500 to report their quarterly numbers, 65% have been better than expected, which should help keep the broader markets trending higher through the rest of the summer and into fall.

More importantly than posting better than expected numbers, companies have been showing impressive earnings growth. According to FactSet Research, blended earnings growth during the fiscal second quarter is 2.1%. If this figure continues through the remainder of earnings reports, it would be the third straight quarter that stocks in the S&P posted earnings growth.

With the earnings season as positive as it has been, it comes as no surprise that the overall markets have remained strong. We have seen the markets make slight corrections over the last week, but still remain well positive on the year. Year to date, the Dow Jones is up 15.0%, the S&P 500 is up 16.1%, and the NASDAQ is up 19.4%.

By all accounts, the economy continues to improve, but investors are right to be cautious regarding the future of the stock market. A big reason why the markets have been as strong as they have been in recent years is the monetary easing program of the Federal Reserve. The Fed has not given any indication that it intends to increase interest rates, but it has hinted that it is getting ready to slow down on its purchase of mortgage-backed bonds. This would result in interest rates floating higher, and could put the brakes on the market's upward trend.

Given the uncertainty surrounding the Federal Reserve, investors are becoming cautious, but the strong earnings season will be too much to ignore. Investors want to stay in the game, but many are going with exchange-traded funds as opposed to selecting individual stocks. This is because ETFs provide diversification, and take a lot of the work out of investing.

I expect this trend to continue following such a positive earnings season.

One ETF that I believe will remain strong in the upcoming months is the iShares Russell 3000 Index (IWV). This ETF is a large cap blend fund that is set up to track the results of the Russell 3000, which measures the performance of the 3,000 largest U.S. companies. Year to date, IWV has traded up 17.9%, which is slightly higher than the Dow Jones and S&P 500, while trailing the NASDAQ by 1.5%.

I am bullish on IWV, especially following the summer earnings reports, but because of the real threat of rising interest rates I would want to hedge any trade on the ETF just in case the market does run into trouble through the rest of the summer.

Chart courtesy of stockcharts.com

A nice hedged trade on IWV would be the November 89/93 bull put credit spread. In this trade, you would sell the November 93 put while buying the same number of November 89 puts for a credit of 20 cents. This trade has a target return of 5.3%, which is 20.9% on an annualized basis (for comparison purposes only). With IWV currently trading at $99.02, this trade has 6% downside protection.

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