CIBC World Markets strategist, Subodh Kumar, says that investors should focus on earnings momentum in the current market climate.

“Recovery in earnings momentum, even if from a low base, is likely to be a key stock market driver,” he says in a new report. “It has been our hypothesis for several quarters that as a result of margin gains, above consensus earnings recovery is likely to be sustained.”

Earnings came through at close to 11% growth in the second quarter, comfortably above the pre-reporting consensus of 6%. CIBC expects consensus of 12% growth in the third quarter to be exceeded and for this trend to continue into 2004.

“We believe that outperformance of Info Tech, Materials, and Industrials in contrast to underperformance in Consumer Staples indicates the market is currently valuing earnings momentum more favorably than earnings visibility. Energy remains the only positive momentum sector to defy this trend. We believe that above consensus results continuing into 2004 would drive the market higher as risk aversion declines and forward looking investor behavior emerges,” he says.

Kumar says that he believes the recovery in earnings will be sustained, despite a lack of topline growth. “The fast market upswing this year and hitherto elusiveness of signs of revenue recovery have prompted concern in several quarters about the sustainability of the market, as well as the robustness of earning expectations. While near term correction risk is possible, we expect recovery to continue into 2004. We believe corporations have restructured operating efficiency significantly and are not about to give up the painfully acquired gains and hence earnings positive surprise is likely,” he says.

He indicates that he doesn’t expect a speedy and smooth trajectory to its 12-18 month fair value target of 1250 on the S&P 500. “Market levels and the evolution of recovery increase the appeal of companies likely to deliver upside surprise. Short term risks in the market are that if the S&P 500 were to move into the 1075 region, during 3Q/2003 earnings reporting for instance…”

However, he suggests that concerns about valuation contraction risk due to rising Treasury yields are premature. “Rather we believe that in an earnings momentum driven market, in which above-consensus earnings continue well into 2004, there is a solid base for market stability and support for rising markets in the long term,” he concludes.