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2013 Earnings Season: Forget Alcoa; Track These Real Bellwethers – Money Morning

This is a syndicated repost courtesy of Money Morning. To view original, click here. Reposted with permission.

At the start of every earnings season, investors typically turn to Alcoa Inc. (NYSE: AA) – the first company in the Dow Jones to report earnings each quarter – as a market bellwether.

That’s because research shows that over the past 10 years when Alcoa beat Wall Street’s earnings estimates, 74% of companies in the S&P 500 also topped estimates.

But Alcoa is no longer a reliable market indicator.

Starting in 2009, when Alcoa has missed earnings estimates, 72.6% of the companies in the S&P 500 still reported earnings better than forecast, according to FactSet.

“With this upcoming earnings season, we wouldn’t put nearly the same confidence [in Alcoa] that we would just five or six years ago,” Ryan Detrick, a Cincinnati-based analyst at Shaeffer’s Investment Research, told Bloomberg News. “The company’s results now predict the direction of the market about as well as a coin flip.”

In fact, Money Morning Global Investing Strategist Martin Hutchinson said Alcoa, the largest producer of aluminum in the U.S., should never have been used as an economic indicator.

“I don’t think Alcoa was ever a very good bellwether; it just reports first,” Hutchinson said. “The aluminum cycle tells you something about manufacturing conditions, but manufacturing is a small part of the economy these days.”

So if not Alcoa, then what stocks should investors pay attention to this earnings season?

Bellwethers for Today’s Market

Some analysts say they’ve found evidence that International Business Machine Corp. (NYSE: IBM) has emerged as a new earnings bellwether.

“If IBM trades up on the day after earnings, the rest of earnings season will be positive 75% of the time,” Paul Hickey, co-founder of Harrison, New York-based research firm Bespoke, told Bloomberg News. “IBM is a better indicator because its products and services are more ubiquitous, even than the [aluminum] used in beer cans, airplane wings and some pickup trucks.”

And just as some follow the Dow Jones Transportation Average to measure the demand for products being shipped, others look to FedEx Corp. (NYSE: FDX) and United Parcel Service Inc. (NYSE: UPS) for the same reason.

But Martin said it’s foolish to look at one company as a gauge for the entire market. He says bellwethers are most useful for assessing sectors, rather than the market as a whole.

Here are his favorite sector bellwethers:

For consumer spending, which accounts for roughly 70% of U.S. GDP and might be the sector that most closely represents the overall economy, follow Wal-Mart Stores Inc. (NYSE: WMT), Target Corp. (NYSE: TGT) and McDonald’s Corp. (NYSE: MCD).

These companies provide products people cannot do without, and for the most part represent low- and middle-income families – the majority of workers.

To get a sense of where the housing market is, look to The Home Depot Inc. (NYSE: HD) and Lowe’s Cos. Inc. (NYSE: LOW) instead of Toll Brothers Inc. (NYSE: TOL), which builds homes mostly for wealthy suburbanites.

Not only are Home Depot and Lowe’s impacted by the building of new houses, but their businesses also depend on whether people can afford to make major improvements and additions to their homes.

For financials, Martin believes only Wells Fargo & Co. (NYSE: WFC) serves as a market indicator. It’s the nation’s leading mortgage lender, accounting for almost one in three home loans today.

Martin says other banks such as JPMorgan Chase & Co. (NYSE: JPM), Citigroup Inc. (NYSE: C) and Goldman Sachs Group Inc. (NYSE: GS) are too involved in “silly, sometimes unethical, high-risk investment-banking.” (Does the London Whale disaster ring any bells?)

And given the tech landscape is always changing, Martin’s not sure there’s a reliable bellwether there, but he likes Google Inc. (Nasdaq: GOOG) better than IBM as an indicator.

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