The onus has shifted to the bulls to make the case that higher levels are justified as the market has clearly cast aside the “green shoots” and “second derivative” arguments and wants results. While a number of data sets have shown we’ve progressed from deep recession to something that reflects a more normal downturn, the labor market figures are ugly and suggest consumer activity isn’t going to be much help, and is more likely to work as a drag on the economy, for some time to come.
The most economically sensitive sectors led the market lower. Industrials held the position of the worst-performing sector and consumer discretionary, tech, basic material and energy shares also took a beating.
Volume was 25% below the three-month daily average on the NYSE Composite – outside of two sessions when volume popped above two billion shares, volume has been at least 20% below the YTD average for over a month now.
Market Activity for July 7, 2009
Earnings Season and the Economy (and what we may expect a few quarters out)Investors will partially shift their focus from the economic releases to the earnings front as Alcoa assumes the traditional role of kicking off the season after the bell today -- although, not really getting started in earnest until later next week. The consensus estimate is for S&P 500 earnings to decline 34% from the year-ago period, which follows a 60% decline in the previous quarter. Earnings results are expected to decline 20% in Q3 and post the first positive results in two years by Q4.
The results will receive a pass during the current season with regard to the degree that cost-cutting plays a role. That is, if overall profits beat expectations largely due to the slash and burn that has occurred within the labor market, investors will accept that but not beyond this period. When third-quarter season rolls around investors will want to see some improvement in sales, some sign that demand has bounced. (The same is true for GDP. We expect a rebound that pushes GDP to post positive results by the third and fourth quarters simply because of the inventory dynamic, but if final sales fail to rebound as well, the market is going to become very concerned)
As is the consensus estimate, we also believe profit results will post positive results by Q4 as the year-ago comparables will be relatively easy to beat and the massive reduction in expenses allows for the potential for big profit growth a couple of quarters thereafter.
The concern that I believe is the issue is that this bounce, whenever it occurs, will be transitory in nature, not the typical rebound that lasts for several years. This is not the normal downturn, it is not a situation in which the Fed cut growth off by raising interest rates as they feared inflation would run to harmful levels – hence all you have to worry about is the scale down in stockpiles. Instead, it was a very large credit event that put us in this situation and this takes additional time to work through; one cannot expect consumer activity to lead GDP higher as debt levels are too burdensome and businesses are unlikely to grow payrolls along the typical expansionary timeline.
What’s more, firms may be faced with significantly higher commodity prices a few quarters out and deal with a margin squeeze as a result. (We see a lot of people talking about how consumer staple stocks are the place to be over the next few years as their higher dividend yields and steady, albeit low, earnings growth makes this area a safe play. Problem is, these are the names hit the hardest by rising input costs). This is one of the downsides to the massive global stimulus plans as large infrastructure projects means big demand for commodities, and that is essentially what will drive those prices higher. In addition, the very large (and unprecedented post-WWII era) deficits and aggressive monetary easing may encourage foreign governments to buy up commodities as a dollar hedge, driving those prices even higher. I do not see how the dollar holds up, even at these levels, based on the policy that is in place.
These are all things to think about as we look out over the next couple of years -- specifically the 18-24 month timeframe. I can see euphoria rising a couple of quarters out as an economic snapback ensues, likely helped in some manner by government stimulus plans and certainly by that inventory dynamic. Even if this rebound is not substantial, people will get excited simply because these will be the first readings of increase in a year.
But the way the U.S., and many parts of the globe, are combating this economic weakness is very short term in nature (short-sighted thinking), and along with separate policy agendas have ramifications for the economy a few quarters out – ie. dollar weakness and higher commodity prices, higher tax rates at exactly the wrong time (if there is ever a right time), energy policy that fails to acknowledge geopolitical realities, and an overall massive increase in government involvement that is never conducive to growth and .
Now we’re hearing increased calls among policymakers for another stimulus package even before this nearly trillion-dollar behemoth is off the ground. What we need is for government to get out of the way; alas that is not going to happen, lets’ face it.
In summary, the euphoria that is likely to ensue when GDP posts its first positive readings after the longest stretch of economic decline in the post-WWII era, and profits in the black for the first time in two years, should be held in check even if it will be difficult (and remember I’m looking ahead here a bit, for now we’re dealing with a market correction off of the 42% march that brought us to 946 on S&P 500 from the nefarious 666 low). We will remain in a rather precarious situation for some time and corralling emotions when stocks move to the next upswing in what may prove to be a long-dated trading range will take discipline. Don’t chase the high end for fear you’re missing out. Be patient and buy on the weakness.
We were without an economic release yesterday and today is another quiet one on this front. Tomorrow we’ll get back to it with jobless claims and wholesale inventories.
Have a great day!
Brent Vondera
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