Earnings Season Begins

Monday, April 8th, 2013

by Mark Hanna, Market Montage

Late Friday the markets moved off their lows in a substantial manner. This is being followed by a small gap up to begin the week. Despite this markets had their worst week of the year but that is a low bar since most weeks have been quite good; the S&P 500 fell about 1% nd the NASDAQ 2%. Much as with late February we are at a very important juncture. Either this was just another pause that refreshes or the first shot across the bow. A litany of warning signals are now out there – just as they were 6 weeks ago. We won’t know if they matter this time around, until after the fact. I would point out the move in the bond market, which is usually “smarter” than the stock market. Note the TLT ETF which is now well above February highs – meaning yields are lower. Low yields usually signal sluggish growth to come. So in late February we saw 10 year yields drop to mid 1.8%s; now we are seeing low 1.7%s.

As for the indexes, the S&P 500 did hold that long term trend line on its first test (light blue line) – each time we have one of these selloffs the question is, is this the beginning of a head and shoulders top? The key as always will be to create a new higher high and not stall on to create a “right shoulder” (left shoulder and head shaded in yellow).

The NASDAQ is weaker as it has been this whole rally due to Apple, it has broken its longer trend uptrend.

The Russell 2000 also is weaker as of late but was very oversold entering Friday’s bad news from the labor report.

NYMO was also oversold – the issue here is even when the market bounces this indicator is basically making it to positive territory indicating a serious lack of breadth.

This is also shown by the % of stocks over their 50 day moving average. Even as the index hit new highs last week less stocks were over their 50 day, this indicates a continuous narrowing of market leaders.

This week we begin earnings season although the heart of it is in the next few weeks. The Federal Reserve meeting minutes are released Wednesday but considering this was minutes from a meeting that had a news conference there should be no major drama. Further, the worry is “tapering” of bond purchases which should be well off the table due to Friday’s poor jobs report. Retail sales are released Friday with expectations of flat, and +0.1% ex-autos. Last week all three key economic reports came in below expectations. Bernanke also has 2 speeches (Mon/Fri) this week.

Copyright © Market Montage

Tags: Earnings Season
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Earnings, Revenue Beat Rates Remain the Same (Bespoke)

Sunday, August 5th, 2012

by Bespoke Investment Group

Since last Thursday, roughly 800 companies have reported earnings, which is nearly half of the total amount of reports we’ve seen since earnings season began on July 9th.  While we’ve seen a ton of reports over the last week, the overall percentage of companies that have beaten both earnings and revenue estimates has stayed the same.  As shown below, the earnings beat rate currently stands at 59.9%, which is just a tenth of a percent below where it was a week ago.  The revenue beat rate is currently at 48.2%, which is a tenth of a percent above where it was a week ago.

The earnings beat rate has been right around 60% for six consecutive quarters now.  The revenue beat rate, however, is well below its historical average this earnings season.
We’re now at the back end of the second quarter reporting period, so we don’t expect these readings to change much from here.

Copyright © Bespoke Investment Group

Tags: Consecutive Quarters, Copyright, Earnings Estimates, Earnings Season, Investment Group, Last Thursday, Nbsp, Revenue Estimates, Second Quarter
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David Rosenberg On Headless Chickens, Topless Americans, And Bottomless Europeans

Thursday, August 2nd, 2012

The S&P 500 has made little headway for two years running and as Gluskin Sheff’s David Rosenberg points out, it first crossed 1380 on July 1, 1999 and since then has run around like a headless chicken (while other asset classes have not). Meanwhile, Europe’s bottomless pit of debt deleveraging (which is as much a problem for the US and China but less ion focus for now) makes the entire discourse of some new and aggressive intervention by the ECB even more ridiculous (and all so deja vu); and the US is facing up to an entirely topless earnings season as revenues are coming in at only 1.2% above last year as it appears Q2 EPS is on track for a 0.2% YoY dip – with guidance falling fast. But apart from all that, Rosie sees the only source of real buying support for the stock market is the stranded short-seller forced to cover in the face of CB-jawboning as there is little sign of long-term believers stepping into the void.

Headless Chicken Markets: BULL OR BEAR?

The cup is half full camp would lay claim that the S&P 500 is not only still up on the year in what has been a challenging 2012 but it is more than twice the lows posted in March 2009.

A discerning bear, however, would point to the fact that the index has made little headway for two years running and keep in mind that it first crossed the 1,380 mark on July 1, 1999 and since then:

• It has crossed 59 times above and below the 1,380 level on a closing daily basis
• Gold is up 515%
• The producer price index is up 45%
• The consumer price index is up 37%
• The 10-year Treasury total return index is up 160%
• The 30-year Treasury total return index is up 215%

So bench-marked against gold prices, producer prices, consumer prices, or bond prices, the secular bear market in equities remains an ongoing phenomenon.

Bottomless Europe: UNRESOLVED DEBT ISSUES

Quote of the day:

What can they do and what would bring about a sustained turnaround in market confidence? There I struggle to find something that would really be convincing.

 

From Jacques Cailloux, chief European economist for Nomura, in yesterday’s NYT (page B3).

Indeed, this entire discourse on some new and aggressive intervention by the ECB is all so ridiculous, and all so déjà vu. The ECB has already done two LTROs and bought bonds outright before. Draghi is still throwing spaghetti against the wall to see what sticks. The bottom line is that monetary policy is a blunt tool to deal with structural insolvency issues as they pertain to bank and government balance sheets. The ECB has only a temporary effect and then bond yields go back up in the periphery. Until there is a move to solve the issue of too much debt relative to the economy’s capacity to service the debt, the problem will re-emerge.

Meanwhile, the credit crunch in the euro area continues unabated, exacerbating recessionary pressures. Cross-border lending by German banks to the periphery has declined nearly 20% in the past seven months to stand at the lowest level since 2005. Overall bank loan books in Spain. Greece and Portugal have contracted 2% as deposits shift to the northern regions. At the same time, the entire regional banking sector is beset by a trillion euros worth of impaired loans, which have expanded 9% from a year ago (2.5 trillion euros are non-performing) with Spain, Ireland and Italy suffering with the largest increases.

Europe for some reason continues to believe that a debt crisis can be fought with more debt. Maybe because they think this strategy has worked in the United States. But it hasn’t and the U.S. is either recession-bound or at best left with a listless economy, and also will likely soon face its own existential moment from a fiscal crisis perspective if it doesn’t get its act together. If left unchecked, the day will come when the entire revenue base will be absorbed by interest expense, defense, health care and social security.

TOPLESS EARNINGS SEASON

The numbers vary by the hour and the data source. but it looks like Q2 operating EPS of S&P 500 companies is on track for a 0.5% YoY dip — by far the weakest since the recovery began three years ago (and well below consensus views of +3% a month ago) . The big problem !s revenues which are coming in just 1.2% ahead of year-ago levels and only 43% are beating their sales targets the lowest since the first quarter of 2009 (only the fourth time in the past 10 years that the beat-rate was under 50%).

The other problem is guidance. The WSJ cites research that finds that 40 companies have already warned about Q3 versus only eight who have raised guidance. We have not seen a gap like this since the onset of the tech wreck in the second quarter of 2001. The bottom-up consensus is now looking for just +3.3% for YoY EPS growth for Q3 — last October, the analysts collectively were calling for 14.5% for the quarter. Talk about a mea-culpa.

Summing It All Up

All that said, the key for all of us is to understand that we are still in the throes of a debt deleveraging cycle that first engulfed the housing and consumer sectors and is now attacking the government sector in country after country. It is not only Europe. China and the U.S.A. too. There is still far too much debt at all levels of society relative to the world’s capacity to service it. This is a critical reason why government and central bank policies aimed at fighting traditional recessions in the past have so far been ineffective and now we have monetary authorities dipping into the toolbox of unconventional balance sheet expansions and contortions.

We have governments battling a debt deleveraging cycle of epic proportions, and by definition, these phases involve debt paydowns, defaults, and rising savings rates — a highly deflationary brew. And it also means that we now reside in a world of fat-tail distribution risks, where the range of outcomes is unusually wide, as opposed to the comfort zone of a classic post-WWII cycle, where we understood what caused recessions and we knew exactly what it took to get out of them, and where there was a much thinner tail to the probability curve.

May those days rest in peace. But once we can acknowledge that we are in a fat-tail world, it is akin to moving into the acceptance phase of the classic five Kubler-Ross stages of grief. This is no time for denial.

Tags: 10 Year Treasury, 30 Year Treasury, Aggressive Intervention, Asset Classes, Basis Gold, Bond Prices, Bottomless Pit, Chicken Markets, Consumer Price Index, Daily Basis, David Rosenberg, Debt Issues, Earnings Season, Gluskin Sheff, Gold Prices, Headless Chicken, Headless Chickens, Producer Price Index, Producer Prices, Secular Bear Market
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Can it Really Be That Easy?

Monday, July 30th, 2012

by Bespoke Investment Group

Throughout the year in reports to our Bespoke Premium clients, we have highlighted the similarities between this year and prior Presidential Election years numerous times.  Most recently, in early July we noted the fact that based on the historical pattern the S&P 500 could see a modest pullback in mid-July coinciding with the kick-off of earnings season.  Sure enough, the market saw some choppiness about a week and a half ago and subsequently rebounded in the middle of last week.  Holding to the historical pattern, that rebound came right at the same time that the market historically sees its summer low.

If the pattern continues, the S&P 500 could be set up for a nice rally to end the Summer.  Will it hold?  Only time will tell, but if the historical pattern has worked so far, what’s to stop it from continuing?

Tags: Amp, Choppiness, Earnings Season, Investment Group, Nbsp, Presidential Election, Pullback, Rally, Rebound
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U.S. Equity Market Radar (July 23, 2012)

Saturday, July 21st, 2012

U.S. Equity Market Radar (July 23, 2012)

The S&P 500 Index rose 0.43 percent this week as the second quarter earnings season kicked off in earnest this week. Energy, technology and materials outperformed as cyclical areas outperformed. Financials were the big underperformers this week, falling more than two percent on disappointing earnings reports.

Strengths

• The energy sector was the best performer this week, rising 2.56 percent and is now the best-performing sector over the past month. Oil & gas drilling and equipment were the best performers, led by Baker Hughes and Schlumberger on the back of strong earnings reports and low expectations.
• The technology sector was led higher by the computer storage and equipment industry group along with internet software and services. SanDisk, eBay and Google were all standout performers on strong earnings reports.
• The best individual stock performer this week was SanDisk, which rose 10.38 percent as the company reported earnings and an outlook that positively surprised street expectations.

Weaknesses

• The financial sector lagged as heavyweights Bank of America, JPMorgan Chase and Morgan Stanley all fell sharply. Earnings or guidance disappointments were the primary culprits, but after a relief rally on last week’s earnings, JPMorgan Chase gave it all back this week falling by more than 6 percent.
• The consumer staples sector was brought down by record high grain prices which negatively impact “protein” companies such as Tyson, which fell 6.56 percent, as well as packaged goods companies such as ConAgra Foods, which fell 4.55 percent.
• Chipotle Mexican Grill was the worst performer, falling 19.21 percent as second quarter sales were less than expected.

Opportunity

• It is all about earnings right now with another heavy week scheduled for next week. While the week ended on a sour note, the market has weathered the current environment pretty well considering expectations coming into the week.

Threat

• While policy-makers in Europe have made strides to stabilize the situation, many risks remain and the situation remains very fluid.
• China recently cut interest rates for the second time in a month, which likely indicates the conditions on the ground remain challenging.

Tags: Baker Hughes, Bank Of America, Computer Storage, Conagra, Conagra Foods, Consumer Staples, Earnings Reports, Earnings Season, Ebay, Gas Drilling, Google, Grain prices, Jpmorgan Chase, Low Expectations, Market Radar, Morgan Stanley, Packaged Goods Companies, Second Quarter Earnings, Second Quarter Sales, Street Expectations
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We Are All Alone

Thursday, July 19th, 2012

by John Nyaradi, Wall Street Sector Selector

Investors are on their own and cannot count on the Federal Reserve to save their portfolios.

Global markets seem to be pricing in a new round of quantitative easing from the Federal Reserve.  Dr. Bernanke and his colleagues will likely comply sometime between now and December.  However, even with more quantitative easing, investors can’t count on the Federal Reserve to rescue the stock market and their portfolios.  We are on our own, and here’s why:

1. Europe’s Debt Crisis

Europe is the crisis that just won’t quit, with Spain, Italy, Greece, ad nauseam , all running out of money. There is simply no solution to this problem as there is simply not enough money in Europe to save Italy and Spain. When the piper finally demands to be paid, no central bank on earth will have the firepower to stop the global financial avalanche that this crisis could trigger.

2. Earnings

Second-quarter earnings season is shaping up as a weak affair with downgrades coming from most every sector. As we all know, stock prices eventually are based on earnings, and no amount of monetary policy, low interest rates or quantitative easing can add profits to corporate bottom lines. Monetary policy can set the stage for, but cannot create, demand.

3. Global Recession

This item is part and parcel of Items #1 and #2. Recession is quickly spreading across Europe. China’s economy, while still growing briskly by developed world standards, is rapidly slowing. The United States limps along with a 1.9% growth rate and recent GDP estimates have been sharply revised downwards. Like antibiotics for a sick person, Dr. Bernanke and his Fed can help but the disease must run its course and the patient must have the physical strength to survive on his own.

4. Diminishing Returns of Quantitative Easing

Each round of quantitative easing has smaller impact and brings greater risks for the global economy. Last week’s interest rate cuts by the European Central Bank, the People’s Bank of China and more quantitative easing from the Bank of England were largely ignored by global markets which, in the “good old days,” would have rallied hard on this sort of same-day global intervention.  Like antibiotics fighting a virus, quantitative easing is losing its effect as the virus grows immune and mutates to offset continued attacks.

5. The Dreaded Fiscal Cliff

Dr. Bernanke has made it quite clear in recent testimony to Congress that the “fiscal cliff” coming up in December is too big for him to manage and that it needs to be resolved to avoid a significant economic shock. The hit to GDP from the fiscal cliff would likely trigger another recession in the United States (See Item #3)

ETF strategies for difficult days

So what are we supposed to do as we try to protect capital, prepare for retirement and secure our financial futures? Several options come to mind:

A. Cash: Cash is king, particularly in deflationary, depression-like environments. The U.S. dollar, represented by PowerShares DB Bullish Dollar ETF (NYSEARCA:UUP) is up some 5% since early May as capital seeks the perceived safety of the U.S. dollar. Cash doesn’t have to be U.S. dollars, either, as Swiss francs have been on a roll, along with the Japanese yen (NYSEARCA:FXY)

B. U.S. Treasury Bonds: Like the dollar, the U.S. is still seen as the safest harbor in an uncertain world and U.S. Treasuries are near record low yields and high prices as money flocks to the perceived safety of Uncle Sam. The biggest moves will probably come in the long end of the curve and iShares Barclays 20+ Year Treasury Bond ETF (NYSEARCA:TLT) is up some 14% since early April. iShares Barclays 7-10 Year ETF (NYSEARCA:IEF) has gained more than 5% in the same time frame. One day, the “short” bond trade will be the position of a lifetime, but that day does not look like today.

So now it’s summertime, but the living is not likely to be easy, at least for awhile. (apologies to George and Ira Gershwin, “Porgy and Bess”)   We can’t count on Dr. Bernanke and his Federal Reserve to save us from what lies ahead but we can use the power and versatility of exchange traded funds to navigate through these challenging times.  We are all alone.

Get Wall Street Sector Selector’s Free Stock Market Warning Indicator!

Disclosure: Wall Street Sector Selector actively trades a wide range of exchange traded funds and positions can change at any time. Wall Street Sector Selector holds a position in (TLT)

Copyright © Wall Street Sector Selector

Tags: Ad Nauseam, Bernanke, Bottom Lines, Debt Crisis, Diminishing Returns, Downgrades, Earnings Season, Enough Money, Firepower, Gdp Estimates, Global Economy, Global Markets, Global Recession, Interest Rate Cuts, Italy Greece, Low Interest Rates, Physical Strength, Second Quarter Earnings, Sick Person, Stock Prices
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Muddling Through…But for How Long? (Sonders)

Sunday, July 15th, 2012

July 13, 2012

by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.,
and Brad Sorensen, CFA, Director of Market and Sector Analysis, Schwab Center for Financial Research
and Michelle Gibley, CFA, Director of International Research, Schwab Center for Financial Research

Key Points

• Equity markets rebounded from their lows, but the move has been less than enthusiastic and convincing. Earnings season is upon us and corporate commentary and outlooks may take the focus away from the macro world—at least for a time.
• Muddling through is the popular phrase on the Street for what’s occurring in the US economy. But how long before a break is made one way or the other—both in the economy and the markets?
• Any progress made at the most recent European Union (EU) Summit appears to have been short-lived and any credible long-term solutions remain illusive. Additionally, Chinese growth continues to slow and concerns over a “hard landing” are growing.

Muddling through. Not the most inspiring phrase and we must admit that we are already tired of hearing it, even as we use it ourselves. But it appears to be the best description of what’s occurring in so much of the world currently. In Europe, policymakers continue to take one step forward, followed relatively quickly by one step back; avoiding a complete collapse, but really coming no closer to an actual resolution to their debt crisis and economic problems—muddling through. In China, growth has slowed and policymakers have been slow to respond and appear willing to accept a lower pace of improvement in exchange for deflating a real estate bubble and containing inflation—muddling through. And in the United States, stocks appear to be largely trading in a range, with neither the bulls nor the bears able to grab the reins and establish a trend; while economic data is mushy, but not overtly negative—muddling through.

The question is how long before the muddling stops and a sustainable direction is established? Unfortunately, while we believe a day of reckoning is drawing nearer and the ability of policymakers to use slight of hand to “fool” the markets into thinking solutions may be forthcoming is growing thin; it appears to still be at least a few months away, and the largely sideways action in stocks is likely to persist.

That doesn’t mean that investors who need to add to their equity exposure should wait until a definitive trend is established. By that time, much of the move will likely be passed and there is always the possibility of unforeseen events impacting the markets to a substantial degree—the so-called fat tail scenarios discussed in the last Schwab Market Perspective. For investors that have a time horizon of five years or longer, we continue to believe equities are attractive here. Valuations appear reasonable, but there are ample near-term hurdles, including the “fiscal cliff,” China’s growth, the US slowdown and the ongoing eurozone debt crisis. If the expectations hurdles have been set low enough , we could see some sharp rallies unfold among riskier asset classes, but there remain negative tail risks as well, and volatility and uncertainty are not likely going away in the near-term.

As we head into the peak of second quarter earnings season, corporations have the spotlight as the macro picture has entered a quieter zone. Judging by the elevated preannouncement ratio for the quarter, we expect to hear uncertainty and caution in the outlooks, as tax policy remains uncertain, the ultimate outcome in Europe continues to be illusive and China’s growth is slowing. With many companies having preemptively announced negative developments with their second quarter performance, expectations have been lowered, which would traditionally set up the possibility of upside surprises. However, we’re concerned that there may be further disappointments to come as the global economy continues to weaken. Regardless, it’s hard to imagine the corporate picture driving action for long as macro developments will likely again take hold as fall approaches.

Recession increasingly likely?

As mentioned above, the US economy appears to be muddling through, but concerns over a return to a recession have grown. Chief among the disappointing reports was the Institute for Supply Management’s (ISM) Manufacturing Index, which came in at 49.7, down from 53.5 and below the 50 level that denotes the dividing line between an expanding or contracting manufacturing sector. This was the lowest reading since July of 2009, but it’s important to note that the index traditionally doesn’t start to indicate recession for the broader economy until it drops below 44.

ISM indicates softness but no recession-yet

Source: FactSet, Institute for Supply Management. As of July 6, 2012.

More concerning was the new orders component-the more forward-looking part of the report-collapsing by 12.3 points, which was its biggest monthly drop since October 2001.

New orders are more concerning

Source: FactSet, Institute for Supply Management. As of July 6, 2012.

However, the service side of the ledger was a bit more positive. Although weakening, the ISM Non-Manufacturing Index remained above 50 at 52.1.

Additionally, the labor market continues to disappoint, although we do continue to see job additions. The ADP Employment report surprised on the upside at 176,000 new jobs for June but the broader government labor report was again disappointing, as only 80,000 new jobs were added. In contrast to the previous month, the unemployment rate remained unchanged at a still-elevated 8.2%. Remember, the unemployment rate is one of the most lagging of all economic indicators, and we have recently seen a positive reversal in unemployment claims, a leading economic indicator.

There are some automatic stabilizers that can help to stimulate economic growth when it slows. One that has been working quite well lately is the reduction in oil prices as demand growth has slowed, helping to put more money in consumers’ pockets. Additionally, other commodity costs have eased as well, although there is growing concern that the heat wave hitting much of the country is causing corn crop problems which has resulted in elevated corn prices. With corn used in so many food items, as well as in ethanol and other products, it is something we are keeping an eye on moving forward.

Government…muddling is thy name!

It’s difficult to imagine employers gaining a lot of confidence and willing to take additional risk by hiring a lot of new workers when they have so much uncertainty surrounding taxes, regulations and ongoing healthcare costs…exacerbated by the looming fiscal cliff. And while politicians on both sides of the aisle appear to recognize the problems this uncertainty is causing, definitive action still appears unlikely. At this point, we believe the most likely scenario is that the lame duck Congress following the elections will pass a three-to-six month extension of current policy so the new Congress can deal with it in 2013—thus avoiding the worst case scenario, but still leaving it hanging out there. One important note, however, due to the WARN Act, government contractors have to preannounce potential job cuts ahead of time. So if we still don’t have a deal before the election, we will likely have multiple mass layoff announcements made, especially from defense contractors, which could have a negative drag on sentiment.

Europe struggles to make progress

Speaking of a negative drag on sentiment, European policymakers have taken squabbling to an art form. More than two years into the sovereign debt crisis, progress remains disappointingly slow. Yet another European summit to curb the sovereign debt crisis has come and gone, and despite unveiling another “grand plan,” doubts remain, and muddling along continues.

The aim for the recent summit was to break the vicious cycle between weak peripheral countries and their weak banks. Low expectations were exceeded, but market relief was short-lived amid lack of details and still-missing components that are likely needed to quell the crisis. Meanwhile, each successive “grand plan” has had a shorter relief rally, as market participants are becoming less patient, while policymakers appear to lack urgency.

Market relief remains tenuous

Source: FactSet, iBoxx. As of July 10, 2012.

Spain remains a concern because its banking system needs capital, estimated at 37 billion euros by the International Monetary Fund (IMF), and 51-62 billion euros in stress tests conducted by consultants hired by the Spanish government. A separate audit on an individual bank-by-bank basis is due in late July.

The problem is the source of capital infusions for Spain’s banks:

• If banks are bailed out by the Spanish government, the Spanish government itself may need a bailout.
• One outcome of June’s summit potentially allows bailout funds to directly recapitalize banks. However, common eurozone-wide bank supervision is required first, and this is a complicated process that may not happen until the second half of 2013.
• The latest “plan du jour,” is to give Spanish banks 30 billion euros in emergency funding without expanding Spain’s government balance sheet. However, this stop-gap plan will not bolster confidence definitely in our opinion, as it not large or quick enough and lending nations remain resistant.

Incompatible cultures and politics hamper agreement on broad solutions and time has been wasted. As the debt crisis has become a crisis of confidence, each successive failure increases the risk that market confidence cannot be restored – once confidence is lost, it is difficult to gain back. From a long-term perspective, a break up of the euro remains an increasing possibility, which could improve the longer-term outlook, but would likely be accompanied by extreme volatility at the time of occurrence.

However, we don’t believe Europe will achieve either full union or break-up in the near-term, resulting in muddling through as the most likely scenario. As such, the rollercoaster loop of sentiment is likely to remain in place, and we continue to believe European stocks will be under-performers.

Global synchronized slowdown

The economic slowdown has gradually spread from Europe in the fall of 2011, to China in the first quarter of 2012, and now the United States appears to be joining. As a result, the JPMorgan Global Composite Purchasing Manager Index (PMI) shows global economic growth falling perilously close to contraction territory.

Global economy losing steam

Source: FactSet, Bloomberg. As of July 10, 2012.

A look under the hood is even more concerning, as the JPMorgan Global Manufacturing PMI has fallen to 48.9. The service economy has been a source of relative strength, but manufacturing has dropped, and manufacturing tends to lead economic trends, as it is more tied to the business cycle. Additionally, the new orders component of global PMIs dropped significantly in June, evident not only in the US ISM report mentioned earlier, but even China cited the United States as a new sign of weakness in June. Lastly, with inventories falling at a slower pace than orders globally, the implication is that an inventory destocking cycle could be upon us, which could result in lower economic activity in the future.

Is there a hard landing in China?

The gloomy sentiment stick appears to have been handed off from Europe, where slow growth appears to be “accepted” by markets, to China. The definition of a hard landing in China is debatable. We think of it as roughly a 3% decline from the potential growth rate of the economy, similar to the decline to zero growth in the United States. This would equate to roughly a 6% level for a hard landing in China, in our opinion.

If China’s gross domestic product (GDP) is still growing more than the 6%, what’s the fuss? We want to redirect the conversation away from “China hard landing” to the “stall speed” concept, where growth slows enough to become self-reinforcing. While an imprecise science, particularly in an immature economy, it feels to us like we are hovering around stall speed in China, much like we are in the United States.

We believe more fiscal stimulus needs to begin quickly to stave off the economic downturn in China. China’s response has been underwhelming thus far, either because growth hasn’t fallen enough, aging demographics have resulted in slower tolerable growth, the desire to not repeat prior mistakes and bubbles, or a desire to prudently allow steam to come out of the economy as it transitions to a consumer-based economy. Regardless, slower growth is likely to be the new normal for the Chinese economy in our view, a concept with which markets are still grappling.

China’s growth has global stock investment implications. Unrelated to economic growth, we believe the Chinese stock market has become less attractive over the intermediate term due to profit-reducing bank reforms, and the large weight of the financial sector in Chinese indexes.

However, we are still believers in the growth story of emerging markets (EM) as a group relative to developed markets. A more forceful fiscal stimulus in China has the ability to stimulate economic growth and stock performance in many Asian nations, which constitute the largest portion of the EM universe.

While a lot of negativity appears to be priced into EM stocks, the impact of the global slowdown is still being priced into developed market stocks, where earnings misses and negative stock reactions indicate that the extent of the weakness may not yet be priced in.

Lastly, we’d be remiss if we didn’t mention nuggets of good news, including inflation falling globally, a change in attitude from austerity to growth, and global central bank easings. Our base case is a global slowdown, not a crash, and investment opportunities remain. Read more international research at www.schwab.com/oninternational.

Important Disclosures

The MSCI EAFE® Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States and Canada. As of May 27, 2010, the MSCI EAFE Index consisted of the following 22 developed market country indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom.

The MSCI Emerging Markets Index^SM is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. As of May 27, 2010, the MSCI Emerging Markets Index consisted of the following 21 emerging-market country indexes: Brazil, Chile, China, Colombia, the Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand and Turkey.

The S&P 500® index is an index of widely traded stocks.

Indexes are unmanaged, do not incur fees or expenses and cannot be invested in directly.

Past performance is no guarantee of future results.

Investing in sectors may involve a greater degree of risk than investments with broader diversification.

International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.

The information contained herein is obtained from sources believed to be reliable, but its accuracy or completeness is not guaranteed. This report is for informational purposes only and is not a solicitation or a recommendation that any particular investor should purchase or sell any particular security. Schwab does not assess the suitability or the potential value of any particular investment. All expressions of opinions are subject to change without notice.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

Tags: BRICs, Charles Schwab, Chief Investment Strategist, Chinese Growth, Collapse, Debt Crisis, Earnings Season, Economic Data, Economic Problems, European Union, inflation, Liz Ann, Long Term Solutions, Lows, Macro World, Outlooks, Real Estate Bubble, Reins, Research Key, Sector Analysis, Senior Vice President
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And Now Back To Reality And The Impossible Earnings Season Stepfunction

Sunday, July 15th, 2012

Last week the S&P erased 6 days of consecutive losses in 30 minutes of trading on the back of news that JPMorgan lost at least 25% of its average annual Net Income in one epic trade, and stands to make far fewer profits in the future, even as the regulators are about to fire a whole lot of traders for mismarking hundreds of billions in CDS. This was somehow considered “good news.” This being the “new normal” market, where nothing makes sense, and where EUR repatriation as a result of wholesale asset sales by European banks drives stocks higher, we were not too surprised. Sadly, even in the new normal, things eventually have to get back to normal. And that normal will come as corporate earnings are disclosed over not so much over the next 3 weeks, when 77% of the companies in the S&P report Q2 results, but in the 3rd quarter. Why the third quarter? Simple: as Goldman’s David Kostin explains, “consensus now expects year/year EPS growth to accelerate from 0% in 2Q, to 3% in 3Q to 17% in 4Q.” Sorry, but this is not going to happen, and as more and more companies preannounce on the back of the global slowdown which many has seeing US GDP down to 1.3% in Q2, and sliding further in Q3 absent some massive QE program out of the Fed, it is virtually guaranteed that the unchanged Earnings precedent that Q2 will set (and there is a very high probability that Q2 2012 will mark the first YoY drop in earnings since the unwind Great Financial Crisis) will continue into Q3 and likely Q4. Because, sadly there simply is no catalyst that will drive revenues higher, even as margin contraction was already set in.

All of this also means that the only possible driver of S&P growth in Q3 (of which we are already 2 weeks deep into) and Q4 will be multiple expansion. This, however too, will be a disappointment. Again from Kostin:

We believe P/E multiple expansion is unlikely in 2H. Headwinds include the fast-approaching Presidential election, associated policy uncertainty, and the looming “fiscal cliff” that everyone outside the beltway decries but no one in Washington, DC seems willing to seriously address.

Not to mention the debt ceiling which is still on track from making US landfall sometime in the next 3 months.

So while short covering rallies are fast and furious, corporations -that traditional deus ex to justify US “decoupling” – now have only one fate before them: disappointment.

Which leaves the Fed. Sadly, not even the extension of Twist can do anything about the biggest concern that banks are currently facing, namely the accelerated decline in reserves, as a result of the prepayment of Maiden Lane obligations and the gradual drop in FX swaps (at least until the next time Europe needs a Fed-based bail out that is). As can be seen in the chart below, Adjusted Reserves have tumbled to level not seen since December, and then May of 2011, both times when the market was about to turn over if not for global coordinated central bank intervention.

Full note from Goldman:

Our 2012 investment thesis for the US equity market has three pillars: a stagnating economy, static P/E multiple, and minimal earnings growth.

First, weak macro data and three proprietary Goldman Sachs indictors support our view of a lackluster economy. The Goldman Sachs Current Activity Indicator (CAI) shows the US economy growing at an annualized pace of just 1.3%. The three-month moving average of our Earnings Revision Leading Indicator (ERLI) diffusion index, a measure of 29 separate micro-driven industry data points, remains below trend at 41, consistent with a softening of our Global Leading Indicator (GLI). On the macro front, the June ISM report slipped to 49.7, the first sub-50 print in three years.

Second, we believe P/E multiple expansion is unlikely in 2H. Headwinds include the fast-approaching Presidential election, associated policy uncertainty, and the looming “fiscal cliff” that everyone outside the beltway decries but no one in Washington, DC seems willing to seriously address.

The third leg of our three part framework will come into clarity during the next several weeks as firms report 2Q results and offer guidance on business activity for the second-half of 2012. 80% of S&P 500 market cap will report between July 16th and August 3rd. Firms to watch next week include: BAC, C, GE, IBM, JNJ, KO, MSFT, PM, SLB, and VZ.

We expect a modest quarterly earnings miss. A shortfall in sales rather than margins will be the primary culprit. Firms will struggle to meet revenue forecasts given weak global demand and a strong US Dollar. Consensus margin expectations are already flat or negative in most sectors.

Bottom-up consensus currently forecasts flat year/year EPS growth, driven by a 4% increase in sales and a 40 bp fall in margins to 8.9%.

Five sectors are expected to post negative earnings growth in 2Q 2012 compared with 2Q 2011: Energy, Materials, Utilities, Consumer Discretionary and Consumer Staples. Analysts forecast Materials and Energy will both post year/year EPS declines of 12% reflecting the sharp fall in commodity prices during 2Q, with Brent plunging by 16% and copper dropping by 10%. In contrast, Industrials and Information Technology will report EPS growth of 7% and 11%, respectively. Apple (AAPL) will again be a standout performer with year/year sales and EPS growth of 32% and stable margins of 25.6%. Including AAPL, the Tech sector is forecast to deliver sales and EPS growth of 9% and 11%, respectively. Without AAPL, the sector will post revenue and EPS growth of 6% and 7%, respectively.

2Q results will affect the market’s outlook for earnings in 2012 and 2013. Consensus now expects year/year EPS growth to accelerate from 0% in 2Q, to 3% in 3Q to 17% in 4Q. Consensus forecasts full-year EPS growth will double from 7% in 2012 to 14% in 2013. In contrast, we do not forecast a steep 4Q 2012 inflection and anticipate EPS growth climbing from 3% in 2012 to 7% in 2013.

Our full-year 2012 and 2013 S&P 500 EPS forecasts remain $100 and $106. Current bottom-up consensus equals $103 and $117. Consensus 2012 estimate has dropped from $107 in January and from $114 in August 2011.

Earnings season focus points: (1) domestic demand; (2) international weakness; (3) margins; and (4) losses from JP Morgan’s CIO unit.

Our ERLI Diffusion Index suggests US micro data improved in June but the three-month moving average remains below trend at 41. In May, our diffusion index of micro driven, industry-level data points fell to 29, the lowest reading since April 2009 (a reading of 50 implies “trend” growth). However, data rebounded in June producing a slightly above trend reading of 53, with 23 of 29 industry variables increasing at a trend or better pace. Examples include hotel occupancy, rail car loadings, and NY/NJ port activity. If this trend persists, it implies that the micro data points which inform equity analysts’ earnings projections may not be as poor on a near-term basis as an otherwise gloomy macro picture suggests. In contrast, our macro driven Global Leading Indicator of industrial production has been contracting at an accelerating rate for the last three months, which our research has shown augurs poorly for S&P 500 returns.

Margins will once again be source of scrutiny. Margins have stabilized at 8.9% for more than a year after having surged by 300 bp from a cyclical low of 5.9% in 2009. Differing margin forecasts explain 80% of the gap between our top-down EPS estimate and bottom-up consensus for 2012. Consensus expects margins to remain flat during the first three quarters of 2012 before rising sharply starting in 4Q and expanding to 10% by year end 2013. In contrast, we forecast margins will hover around 8.9% for the next two years.

JP Morgan CIO trading losses. This morning JPM reported 2Q EPS of $1.21, 59% above consensus expectations of $0.76. Of course, analysts had cut estimates by 38% since May after the bank disclosed large trading losses in its chief investment office. The JPM CIO losses of $4.4bn reduce 2Q 2012 EPS for the S&P 500 by $0.49. For the Financials sector, year/year EPS growth in 2Q is anticipated to be 8% including JPM and 12% without.

Tags: 2q, 3q, 3rd Quarter, Asset Sales, Consecutive Losses, Contraction, Corporate Earnings, Earnings Season, European Banks, Financial Crisis, Global Slowdown, Goldman, Kostin, Net Income, Nothing Makes Sense, Q3, Q4, Qe, Repatriation, S David
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All You Had To Do Was Wait (Grant)

Tuesday, July 10th, 2012

From Mark Grant, author of Out of the Box

All You Had To Do Was Wait

“What makes people so impatient is what I can’t figure; all the guy had to do was wait.”

-Ken Kesey

It was approximately twelve months ago that I called for a U.S. ten year at 1.25%. The yield back then was around 2.25%. We are a scant 26 bps from my prediction now and we have seen a 75 bps drop in yield during this time period. This has been fueled by the continuing “moments” generated in Europe and the demand for anything having some sort of safe haven status. We now have a second driver which is the recession in Europe and the substantial slowdown in the economy of China which I predict will place America in recession by either the fourth quarter of this year or the first quarter of the next.

The American stock market, always myopic in its view, is about to be hit by what it does pay attention to which is earnings. Europe represents 25% of the global economy and the recession there is about to have a very substantial impact on the revenues and profits of many American corporations. It was inevitable, as hindsight will expose, and now as our earnings season gets underway it will get documented in the numbers. If you don’t delight in losing money you will find that the yields of many senior and subordinated corporate bonds far outpace the returns of dividends and certainly the depreciation in value will be far less. Further, in times of economic stress, it is far safer as has been proved time and time again to be towards the top of the capital structure in bonds rather than in the bottom of the capital structure which is equities.

I can report a wide array and a great diversification of viewpoints on just what will take place in Europe but what also can be said with certainty is that most institutional investors all agree that there is a lot of risk on the table now. As part of this process I also wish to congratulate the media. Many commentators in the Press or on television are no longer willing to take the official press releases as fact. There are more people who are not only questioning the headlines but who are looking past them in trying to decipher not only their accuracy but there meaning. I suppose this has occurred by one announcement after another coming from the Continent that was so shaded and so misleading that eventually people woke up to the fact that inaccurate data was being provided and being provided in a systemic fashion. Then there is the timeline issue where plans are tossed out, do not materialize and are being held to account as mollifying statements that somehow never seem to achieve their goals. Whether it was the statements of the IMF and the EU that the new structural plan for Greece would produce a debt to GDP ratio of 120% or the giant firewall that would prevent Spain or Italy from ever needing to be bailed out or the bailout for Spain which their Prime Minister called “A Great Victory for Europe;” the cries of “wolf” are falling on less and less accepting ears.

“The secret of being a top-notch con man is being able to know what the mark wants, and how to make him think he’s getting it.”

-Ken Kesey

It may work, for a moment, to rally equities after the next new piece of sliced white bread is announced but then the reaction flattens out and then the market declines as reality sneaks back in and finds its rightful place at the table. From the very beginning with the first European bank stress test which counted what Europe wanted to be counted and ignored what should have been counted to the second one which was falsified by its methodology; results begin to occur and calamities begin to happen, such as with Dexia, as the real data forced what the phony data reported tried to hide. Europe may cook the books and allow for risk-free assets or the Spanish central bank may allow for “smoothing” and carrying Real Estate at levels with no reflection of reality in them but when mortgages are not paid and commercial loans are delinquent; the lack of revenues and profits tell the accurate tale whatever was allowed to be ignored or not.

All of the time wasted on firewalls and great deceptions worked in the short term but the height of a fence does nothing to help a horse or a nation which is sick inside them. Europe has vastly overspent and tried their best to whitewash the financials of the countries and the European banks and now, and each quarter out for some time; we are going to see a worsening financial landscape for the European nations and their banks. This will not be Armageddon or the end of the world but it is going to be quite painful and have a decided impact on the United States and perhaps the scaring may be deep. In Europe that have mouthed so much nonsense for such a long period of time that they have come to believe in what they have manufactured. This is not uncommon historically but the depth and breadth of it is without comparison. Germany says one thing to placate France and Italy believes the drivel that is touted by the Netherlands and now Greece wants the ECB to forgive their $238 billion in Greek debts on the basis of a united Europe, which would bankrupt the ECB, and then it becomes clear that someone has to pay for all of this and countries start banging on the doors of the asylum to get out. Listen carefully; the banging has begun and will grow loader and more raucous during the balance of the year.

“The world news might not be therapeutic.”

-One Flew Over The Cuckoo’s Nest

Tags: American Corporations, American Stock Market, Bps, Capital Structure, Commentators, Corporate Bonds, Depreciation, Diversification, Earnings Season, Economic Stress, Economy Of China, Global Economy, Having Some Sort, Hindsight, Institutional Investors, Mark Grant, Recession, Safe Haven, Slowdown, Substantial Impact
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Are Weak Earnings Already “Baked In”?

Tuesday, July 10th, 2012

I’ve been speaking quite a while about the difficult this earnings period could be. I’ve actually been more concerned about future guidance – Q3 and Q4 seem wildly optimistic in the context of a global slowdown, but as we get closer to the actual reporting period I’ve become concerned with the Q2 data as well. We’ve already had a flurry of high profile warnings and with both an European and Chinese slowdown, a lot of the multinational revenue growth could be in question. The stronger dollar also does not help these firms.

But the stock market is all about expectations. Many times we see a company lowball guidance or reduce expectations over the course of a quarter only to “beat” them on the day of earnings and see the stock surge. That’s just part and parcel with the Wall Street game. And I’m starting to see a lot of stories in the past 2 weeks about the potential for a bad earnings season. So has this become “baked in” at the macro level? That could be the main question to answer over the next 4 weeks.

Story 1: Reuters - Investors Brace for Shaky U.S. Earnings Season

Earnings season begins on Monday with U.S. companies facing a litany of issues that could make second-quarter reports look dismal.

Corporate outlooks are at their most negative in nearly four years and companies that have already reported have shown lackluster growth. Nearly two dozen S&P firms have already cited Europe’s woes – which seem to be worsening – as a concern.

In addition, more than 85 members of the Standard & Poor’s 500 lowered expectations in the last several weeks and the quarter’s expected earnings growth of 5.8 percent is entirely due to Apple Inc and a big earnings gain for Bank of America Corp due to a mortgage settlement last year.

Earnings growth is estimated to decline 0.4 percent without the benefit of Apple and Bank of America.

Revenue is seen up just 1.7 percent, down from 5 percent growth in the first quarter, the data showed.

Corporate outlooks are the most negative they’ve been in years. Negative-to-positive earnings guidance is now at 3.3 to 1, the worst since the fourth quarter of 2008.

Story 2: AP – Get Ready for the End of Record Corporate Profits

For almost three years, no matter what has rattled the financial markets — a debt crisis in Europe, high gasoline prices, a slower economy — investors have been soothed by rising corporate profits.

The storyline became as predictable as a soap opera’s. But when the latest round of corporate earnings starts rolling in this week, look for a twist: Profits are expected to fall.

Stock analysts expect earnings for companies in the Standard & Poor’s 500 index to decline 1 percent for April through June compared with the year before, according to S&P Capital IQ, the research arm of S&P.

That would break a streak of 10 quarters of gains that started in the final quarter of 2009.

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Tags: Bank Of America, Bank Of America Corp, Earnings Gain, Earnings Growth, Earnings Season, Global Slowdown, Litany, Macro Level, Outlo, Outlooks, Q3, Quarter Reports, Reuters, S 500, Season Earnings, Second Quarter, Stock Market, Stock Surge, Story 1, Street Game, Woes
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