The war is over so there is one less item for investors to fret over. Now investors can focus on the economy and earnings. Judging by what I have seen over the last week there has been nothing to celebrate. Companies were able to beat expectations but what else is new? When you lower standards by more than half just before earnings are reported it should come as no surprise that companies were able to beat them. The best that can be said is that they weren't that bad. Companies that lost money the year before were able to squeak by with profits. Companies that were losing money trimmed back their losses. Most of the profits in the S&P 500 are coming mainly from energy and financials. The energy sector is expected to account for over 90 percent of the indexes’ earnings gains. The rest is expected to come from the financial sector. Outside energy and financials there has been nothing to celebrate. Even then spectacular gains in the energy sector hasn't translated into gains, which like the rest of the market has been locked into a narrow trading range.
In fact, there has been no clear-cut pattern that can be surmised from pouring over earnings statements. There have been a few surprises, a few disappointments, and a few contradictions. The number of companies beating estimates has increased. That is a result of earnings estimates cut more than half from 17 percent to around 8 percent for the quarter. On the other hand, the number of companies announcing warnings has increased to a margin of 2.2-1 from 0.8-1 a year ago, so we now have more companies warning than before and more companies beating estimates. However, as mentioned before the only reason we have companies beating estimates is because they have been lowered to such a point that everybody now looks good even if they lose money. Those companies that have surprised on the upside did so through cost cutting (job layoffs) and through currency translation gains thanks to a falling dollar.
What can we expect next other than the markets to remain in a narrow trading range? The earnings recovery forecasted for this year is like the miracle recoveries forecasted the last three years. The forecasts are all backend loaded. The miracles all happen in Q3 & Q4. Many companies such as Nokia, Microsoft and many others have lowered guidance going forward. In Nokia's case, earnings will be down next quarter because of new layoffs for which the company will take a large restructuring charge. Other companies are lowering guidance and warning that they see very little improvement for the rest of the year. The markets recent rally like the rallies that have preceded it have all been based on hype, hope, and nothing more. There hasn't been anything concrete behind the rallies, nor have there been any earnings miracles that would justify today's market valuations. Accounting scandals are still with us, CEO pay is still out of control, companies aren't expensing stock options, while they continue to issue options that dilute shareholder value. Industry is still plagued by overcapacity, lack of pricing power, and the distribution channels are backing up with unsold inventory. Job layoffs are continuing at a torrid pace while unemployment claims rise.
It might be appropriate at this point to ask what is next. The economic indicators keep getting worse as today's LEI (leading economic indicators) points to further weakness ahead. Perhaps more troublesome for the markets is that valuations remain high. According to this week’s Barron's, the Dow is still trading at 27 times earnings and the dividend yield is still only 2.36 percent. The S& P 500 is selling at 32 times trailing earnings with a measly dividend yield of only 1.8 percent. Despite the numerous attempts by analysts and anchors to sell the public on the concept that stocks are cheap, they remain grossly overpriced. The only way they become reasonably priced is to evaluate them based on some unrealistic forward earnings multiple. Do analysts really believe that profits will rise over 80 percent this year to get the markets down to levels that are more reasonable? If they believe that trailing earnings for the S&P 500, which are currently $27.59 will rise to $48-50 by yearend, what and where will the catalysts for such an advance come from? I just don't see the catalyst nor have I seen or heard companies reporting earnings give one. Most companies have lowered expectations and have announced further cost cutting and downsizing of their labor force. Therefore if there is a catalyst on the horizon, it sure isn't visible at this time. The only catalyst seems to be the government. With the Fed now monetizing debt, the government is running deficits, and with fund managers gambling by overpaying for stocks, the markets downward trend seems to be arrested or at least to have narrowed.
Given the multiple bubbles in the economy I can see that there is every effort being made to keep them afloat. The Fed may lower interest rates another half a point by summer if the unemployment numbers get worse. The Fed is trying to peg interest rates by monetizing debt, and the money supply keeps expanding at double-digit interest rates. The Fed is making sure that the financial system is kept liquefied. If you are a consumer or homeowner, it has never been easier to go deeper into debt. There are no money down programs, there are no payment programs, there are zero percent loans, negative interest loans, no interest loans, and loans with no sales tax. Maybe zero percent mortgages are next. To put it simply, we are still in a bubble and still suffering from the bubbles created in the 90's. The only difference is that now in order to avoid a bursting of these bubbles, we are creating multiple bubbles to take their place.
Given this background, what should an investor do? The one piece of advice I can give is caution and don't believe everything you hear or read. Instead, look around you. If your neighbor on the left has lost his job, we still may be okay. If your neighbor on your right loses his job, the economy is weakening. If the neighbor across the street loses his job, we’re in a recession. If you lose your job, we're in a depression.
Look for a major fiscal and monetary stimulus package to emerge by summer. It will include major tax cuts, spending programs, rate cuts of as much as half a point, and for the Fed to continue to monetize debt. It is still possible that the combination of these two efforts will give us one last hurrah. Lasting until November of 2004 will depend on the size of the tax cuts, which is why the opposition will try to limit them.
As far as the markets are concerned I recommend reading an article in this week’s edition of Barron's called "Unreal Expectations." The article discusses that over the last century half of the stock market’s return has come from dividends. A third has come from inflation and about a third has come from growth, including the expansion of P/E multiples. The only problem for investors going forward is that the 10 percent returns over the last century started at points when the dividend yield was much higher and P/E multiples were much lower. Price earnings multiples averaged 15 throughout much of the last century. During periods that the markets experienced explosive growth such as 1941 and 1981, the P/E's were as low as 7 & 8. Dividend yields were also as high, reflecting investors’ perceptions of risk associated with stock investing.
By comparison to today where P/E multiples are over 32 and dividend yields are as low as 1.8 percent, the returns from equities are bound to be much lower going forward. The only way to correct this is for stock prices to go much lower to the point where they once again become bargains. Therefore, a much more important component of stock returns in the future is going to come from dividends. These returns may become even more attractive if the President's tax bill makes half of a dividend non-taxable. Unlike other nations, the U.S. taxes dividends twice.
The good news regarding dividends is that it is getting easier to find high quality companies that offer attractive dividend yields that pay more than Treasuries. Furthermore, dividend returns and stock market returns are much better during periods of inflation. The government and the Fed is now hell bent on creating inflation in order to avoid a deflationary depression. The CPI and PPI numbers are starting to increase, which can be good news for investors who own companies that have the ability or the franchise power to pass on higher costs. Remember, a third of the return from equities this last
century came from inflation. And it is inflation that is now upon us. When your house rises 20 percent or more a year, that is inflationary; when movie tickets go up 10 percent, that is inflationary; when your utilities, gasoline costs, heating bills, phone bills, cable bills, or property taxes go up, that is inflationary. You don't have the option of not counting these costs when you have to pay for them. As a consumer, these rising costs are real and not imaginary as so many of the government’s economic numbers and gauges are concerned.
Fund managers chase tech stocks and Internet stocks with no real earnings or declining earnings, instead of look at investing in "things" that people need in order to live. People need energy, they need food, they need water, and they need medicine. As the value of paper diminishes as it is depreciated, they will also gravitate towards real money, which is reflected in silver and gold. Also look at hard currencies. Central banks are divesting themselves of dollars and will look at places to direct new money or old dollars. The Euro and the currency of raw material countries look attractive. Long-term Treasury investments should be avoided given the inflationary polices of the Fed. The bond market is one of the next bubbles to burst.
What is most likely to happen next is that we either get a hard correction triggered by some unforeseen event such as a terrorist attack, or the economic and earnings numbers get worse and can't be covered up by spin. That, in my opinion, is what happens next. After that, I believe the monetary and fiscal stimulus gives us a longer-lasting bear market countertrend that could take us into next year and the election with new records on the Dow.
Stock indexes lost ground today as speculators sold off shares of companies that rose last week due to better-than-expected earnings. Despite the decline the number of shares advancing over the shares declining rose by a 5-4 margin. Volume was low with only 1.1 billion shares exchanging hands on the NYSE. The major story affecting stocks today was the government lead forecasting gauge. The Leading Economic Indicators declined in March for the second consecutive month. The Conference Board's LEI indicator fell 0.2 percent last month after dropping 0.5 percent in February. Today's big winner was gold and precious metals shares. Gold shares experienced their biggest gains in over two months. The VIX and the VXN continue to fall with VXN dropping .39 to 35.49 and the VIX dipping .32 to 24.27.
Overseas Markets
Investors in European stocks are much less optimistic in their forecasts for corporate-profit growth in the region than analysts are. The closing of this gap may cause the market rally of the past month to stall. The Dow Jones Stoxx 50 and Stoxx 600 indexes have risen by 22 percent and 19 percent, respectively, since closing at their lowest levels in more than six years on March 12.
Japanese stocks have been left out of a global market rally this month as investors deal with a new concern: share sales by company pension funds. The Nikkei 225 Stock Average is the worst performer among benchmark indexes for 48 countries and for Europe. The average has lost about 3 percent while the MSCI World Index, a global benchmark, has climbed 6 percent and South Korea's main indexes have jumped more than 20 percent.
The Calm Before the Storm, or Prelude to a Party - Jim Puplava
Surfer
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22-04-2003 06:32
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