Posts filed under “Think Tank”

On the Cusp of a Fascinating Earnings Season

Good Evening: The major U.S. stock market averages rose for a sixth straight day today, and the S&P 500 set a new closing high for 2009 in the process. I will first breeze through today’s events before examining what I think could be a fascinating earnings season. Since there are important similarities and differences between this quarter and last, I’ll try to look at the U.S. markets from different angles in search of predictive clues. Fundamentals, technicals, sentiment, and Fed policy all go into the mix, but it will just as important to watch how various stocks REACT to their earnings reports. Whether investors feel forced to “chase performance” into year end, or “lock in performance” by taking profits will likely be the swing variable. Taken as a whole, these reactions will set the tone for how the averages perform during the balance of 2009.

During the past two weeks, stocks corrected a bit when the economic data turned squishy and because the Fed threatened to some day cap the gusher of liquidity still flooding the markets. Reaching their nadir on the very day of the nonfarm payrolls release, stocks have since come roaring back. Today’s Columbus Day rally was simply a light volume extension of last week’s upturn. There was no news of significance, including a report by our Department of Homeland Security that Al Queda is still alive and has sympathizers living in our midst. This non news flash coincided with some gentle profit taking this afternoon, but most of the indexes clung to gains by day’s end. The final tally saw the Russell 2000 trail with a fractional loss, while the Dow Transports were today’s best performer after tacking on 0.8% . The bond market was closed, the dollar continued to weaken, and commodities continued to levitate. Led by a 2% gain in crude oil and very firm grain prices, the CRB index rose 1.7% today.

Back in early July I noted that the averages went into Q2 earnings season fresh off a correction of nearly 10%. Expectations weren’t very high, the earnings bar companies had to jump over was set pretty low, and many portfolio managers were less than fully invested. While I cannot claim to have predicted the resulting rally during the entirety of the Q2 reporting period this summer, I did note the “set up” could easily lead to an updraft in equity prices. I also noted that if disappointments were to occur, then the stage would also be set for a retest of the March lows. The one outcome I felt safe in predicting in July, however, was that prices would NOT go sideways. Now that Q3 earnings will start arriving in a rush starting tomorrow, we have another interesting set up, one that is at the same time both similar and different from what we saw back in July.

The similarities include a quantitatively easy Fed, generally rising risk appetites and an unemployment-data-induced correction just prior to the onslaught of earnings reports. The differences, though, are more glaring. As we head into tomorrow’s announcements by JNJ, INTC, and CSX, the S&P stands at 1076, a full 23% higher than the closes in the 870s when Alcoa kicked off the Q2 season back in July. Back then, the economy was weaker, earnings expectations were lower, the technical underpinnings of the market were starting to weaken, and investor sentiment was anything but trusting. Let’s examine how these variables now look in October before trying to draw any conclusions.

Fundamentals/Economic Backdrop: Compared to the negative GDP reported in Q2, the economy in Q3 looks almost vibrant. “Cash-for-clunkers” and other stimulus programs gave the U.S. economy a boost this quarter, as did a modest uptick in demand and some inventory adjustments. There are many (including Messrs. Roubini, Rosenberg, Soros, and Gross — see below) who view the economy’s response to all the stimuli pouring out of Washington as temporary — and prone to reversal as soon as Q4. I have a lot of sympathy toward these views, but the upcoming earnings reports are for Q3. Temporary or not, GDP growth might have been 3% or more for the quarter just ended, and we should also keep in mind that various leading economic indicators are still flashing bright green. Then again, all of these tailwinds are well known, if not priced in to equities at this level, so it’s hard to say this variable is of much help in divining the future. We simply do not know if the “new normal” is yet ready to assert itself as the consensus outcome. Valuation is also a bit of problem, but though many would call them fundamental indicators, I’ll save elevated P/E and P/B ratios for the next section.

Technical Indicators: The “tape”, which is simply the catch-all title for various technical indicators, has been very firm in the run up to the earnings season that will soon be under way. There have been many more up days than down days, breadth has been positive, and corrections have been very brief. Looking at the averages themselves, the highs and lows have been sequentially higher, and the momentum crowd has rarely been happier. The biggest negatives are volume and valuation. The former has been disappointingly weak and is hard to square with a new bull market in equities, while the latter looks increasingly stretched. One must completely ignore P/Es based on trailing twelve month earnings, and even “core earnings” (which conveniently ignore write-downs) must be rationalized to fit S&P 1076. It’s only when “normalized earnings” (i.e. pre-recession) are conjured up that current valuations make any sense at all. Another less than stellar reading, depending on just how “book value” is measured, has most P/B ratios in the stratosphere after all the post-bubble write-offs. And, if equities pull back from here, it will be hard to dismiss the potential for a double top in the S&P (the intraday high in September was 1080; today’s high was 1079). The net-net is that while the tape is pretty firm, expectations are high and a sell off from a potential double top cannot be ruled out.

Sentiment: As you will see in the table below, AAII investor sentiment is currently mixed. Other measures I’ve seen during the past 10 days are likewise close to neutral. The journey to this mid point between optimism and pessimism has been a wild one this year. Pessimism dominated during most of the first half, while optimism has had the upper hand since May. This conflict is quite apparent in some of the risk appetite measures tracked by Credit Suisse. Jim Cramer can claim all he wants that institutional investors are afraid of their investing shadows, but CS says risk appetites for U.S. equities and U.S. credit have risen from panic to euphoria in well less than a year. Like sentiment among individual investors, measures of institutional sentiment have pulled back somewhat since the S&P hit 1080 on an intraday basis in late September. The VIX could be considered a technical indicator, but it’s really one of the best sentiment indicators around. Down from 80 last year, the VIX has notably declined. But the VIX has not yet printed below 20, which usually marks the upper end of the complacency zone. As an indicator therefore, sentiment is neither bullish nor bearish right now.

Investor Survey Results (an AAII exclusive)
Results as of October 1, 2009

This week’s survey results saw bullish sentiment rise to 43.55%, above its long-term average of 38.9%. Neutral sentiment rose to 20.97%, below the long-term average of 31.0%. And bearish sentiment fell to 35.48%, above the long-term average of 30.1%.

Bullish 43.55%
Neutral 20.97%
Bearish 35.48%

Fiscal and Monetary Policy: The Fed has been easing since August of 2007, and monetary policy can only be described as exceptionally easy. The Fed ruminates once in a while about having to remove all the monetary stimulus they’ve unleashed into the banking system, but it is highly unlikely the FOMC will vote for a rate increase any time soon. The ECB, the G-20, and Chairman Bernanke himself have all chatted up the need to be responsible “at some point”, but Mr. Market looks to be from Missouri on this claim. How else can one explain the continued weakness in the dollar in the face of policy threats and the supposed embracement of “a strong dollar” by top officials? For its part, Congress may have tried to give away the store with the 2009 stimulus package, but 2010 is an election year. Does anyone think Congress will sit on its hands as unemployment closes in on 10%? Furthermore, does anyone really believe that the Fed will tighten during next year’s (re)election campaigns? Market participants want to believe that Congress and the Fed will act responsibly, but it’s hard to see our government officials (whether elected or appointed) taking any action which might threaten economic growth.

So, if — other than an easy Fed — the indicators I’ve cited point up, down, and sideways at the same time, then what should an investor try use as a guide during the upcoming earnings season? The fundamentals are OK for now, but they could weaken. The technicals are firm, but not universally so, and sentiment measures are not conclusive at current levels. Valuations matter, but only over time. They are a notoriously poor tool for market timing. If you are content to just stay invested as long as the Fed continues to hold rates near zero, then be my guest. It’s worked before. But since we might not know just when the Fed will tighten, or when the economy might weaken, we need to watch for signs that investors have had their fill of equities. Perhaps Q3 earnings will give us the clues we need.

Since there have been very few negative pre-announcements, I have little doubt that earnings in Q3 will meet or beat consensus estimates. What’s important is not whether these reports “beat the street”, but how “the street will greet” the expected good news. In the months after the March lows, stocks rallied on all news — good, bad, or indifferent. But lately, some companies haven’t roared ahead after reporting decent numbers. Alcoa’s steady decline after a surprisingly good Q3 may or may not be representative of what’s to come, but it would be important if it became a trend. It’s easy to explain away a stock that drops after missing its numbers, but it’s tougher for market participants to swallow a lower stock price after the company in question logs stellar results. Whether it is due to simple profit taking or something more sinister in the outlook for the company, stocks that fall after releasing good news do not often make ideal purchase candidates. If it happens to enough companies during earnings season, then a correction or worse might be in the offing.

Then again, if most stocks rise after positive earnings announcements, then the rally might still have legs. The S&P 500 could even rise to 1121, which is the halfway mark (in technical parlance, a 50% retracement) between the 2007 high of 1576 and the 2009 low of 666. Paying attention to the overall reaction to earnings rather than to the earnings themselves may just yield some important directional clues these next few weeks. We’ll soon see if an almost 60% rally off the March lows is indeed too much too fast, or whether there’s still a dance left in the old girl yet. In fact, some will claim that this entire commentary is just a long-winded way of saying, “don’t fight the tape”. I don’t mind a bit, just so long as folks don’t confuse the above with “momentum investing”. I honestly think the upcoming earnings season will reward thoughtful investors. Whether portfolio managers are in the mood to chase profits or lock them in, how they respond in the weeks ahead will be important. If we can pay attention to market reactions on a micro level, they just might reveal some macro level insights.

– Jack McHugh

U.S. Stocks Rise as S&P 500 Climbs to One-Year High on Earnings
Dollar Rises, Bonds Fall on Bernanke Comments; Commodities Drop
Trichet Signals Rates on Hold as Euro’s Gains Threaten Recovery
Roubini, Prechter See Stock Declines as Soros Warns on Economy
Investment Outlook: Doo-Doo Economics, by Bill Gross, PIMCO

Category: Markets, Think Tank

Quarterly Review and Outlook – Q3 2009

I look forward at the beginning of every quarter to receiving the Quarterly Outlook from Hoisington Investment Management. They have been prominent proponents of the view that deflation is the problem, stemming from a variety of factors, and write about their views in a very clear and concise manner. This quarter’s letter is no exception, where they once again delve into the history books to bring up fresh and relevant lessons for today. This is a must read piece.

Hoisington Investment Management Company ( is a registered investment advisor specializing in fixed income portfolios for large institutional clients. Located in Austin, Texas, the firm has over $4-billion under management, composed of corporate and public funds, foundations, endowments, Taft-Hartley funds, and insurance companies. And now let’s jump right in to the essay.

John Mauldin, Editor
Outside the Box

Ponzi Finance

The Federal Reserve reported that as of June 30, 2009 total U.S. debt was $52.8 trillion. Total U.S. debt includes government, corporate and consumer debt. Importantly, however, it does not include a few trillion in “off balance sheet” financing, contingent unfunded pension plans for corporate and state and local governments, or unfunded liabilities of the U.S. government for such items as Medicare, Social Security and other programs. Currently GDP stands at $14.2 trillion, so there is approximately $3.73 in debt for every dollar of output in the United States, a level unprecedented in our history (Chart 1). Normally, debt levels as a percent of GDP would be uninteresting and immaterial; however, the current level of debt is unique in two ways. First, the asset side of the balance sheet purchased by the debt is falling in price. Second, the money that was borrowed to purchase those assets was often fraudulently expended. Neither the borrower nor the lender really expected the debt to be serviced. Rather, each party expected the asset price to rise extinguishing the debt.


This type of financial arrangement was correctly analyzed by the famous American economist Hyman Minsky in his paper, “Financial Instability Hypothesis”, in which he described three phases of debt financing. The first is “hedge finance”, where the lender expects a return on both principal and interest. The second is “speculative finance” where the lender expects to get interest on the loan but perhaps not the principal. The third case, where the lender expects neither the principal nor interest to be returned, is referred to as “ponzi finance”. This was typified in the last business cycle by loans issued without documentation, no down payment home loans, extremely low cap rates on commercial real estate, and the high leverage borrowing ratio of private equity funds. Even ponzi finance works as long as asset prices are rising. But once the bubble is pricked, the debtor is left with declining asset values that preclude the rollover of their obligations.

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Category: Think Tank

2nd quietest volume day of the year

While the market has come off its intraday highs, it didn’t take much as volume is running at the slowest pace since Jan 2nd, the Friday after New Years Day. With earnings reports upon us in earnest beginning tomorrow, the stock market becomes a different place in that it more discriminates between those that deliver…Read More

Category: MacroNotes

Oh, Those Financials!

Oh, financials, financials, financials. Here we go again. JPMorgan Chase reports quarterly profits on Wednesday; Citi announces a quarterly loss on Thursday, Bank of America delivers its results (no one knows if loss or profit) on Friday. The parade will continue right through Halloween.

Cumberland does not use single stocks in its US equity account management. So while we are keenly focused on these reports, we’ll review some of the applicable ETFs instead.

Since March 9 the big bank ETF that tracks the KBW Bank Index has delivered a total return of 145%. The three banks reporting this week constitute 25% of the weight of the exchange-traded fund (ETF) that mirrors that index. Its symbol is KBE. These big banks are deemed “too big to fail” and have benefitted greatly by obtaining the federal government’s direct support and guarantees. That subsidy will be revealed in their positive surprises to earnings reports

Contrast KBE with KRE. It is the exchange-traded fund composed of regional banks that have not been deemed “too big to fail” by the Washington-based troika of Treasury, Fed, and White House/Congress. Many regional banks are small enough to be resolved by the FDIC, and many suffer from a greater concentration of deteriorating commercial loans than their larger brethren. Their status is reflected in the performance of their stocks. KRE has had a total return of only 49% since March 9. It has actually lagged the performance of the S&P 500 index, represented by the “Spider.” SPY has had a total return since March 9 of 59%.

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Category: Think Tank

Self sustaining or not? That is the question.

In a harbinger of what’s to come in terms of Q3 growth, Singapore is the first nation of significance to report Q3 GDP and it was better than expected. Its GDP grew 14.9% q/o/q annualized, .4% higher than forecasts. Q3 Earnings reports beginning in earnest this week will translate for us what the statistical global…Read More

Category: MacroNotes

Killing the Goose

Killing the Goose
October 9, 2009
By John Mauldin

Killing the Goose
What Were We Thinking?
Let’s Play Turn It Around
Detroit, the Red Sox and the Yankees, and Traveling Too Much

Peggy Noonan, maybe the most gifted essayist of our time, wrote a few weeks ago about the vague concern that many of us have that the monster looming up ahead of us has the potential (my interpretation) for not just plucking a few feathers from the goose that lays the golden egg (the US free-market economy), or stealing a few more of the valuable eggs, but of actually killing the goose. Today we look at the possibility that the fiscal path of the enormous US government deficits we are on could indeed kill the goose, or harm it so badly it will make the lost decades that Japan has suffered seem like a stroll in the park.

And while I do not think we will get to that point (though I can’t deny the possibility), for reasons I will go into, there is the very real prospect that the upheavals created by not dealing proactively with the problems (or denying they exist) will be as bad as or worse than the credit crisis we have gone through. This is not going to be something that happens overnight, and the seeming return to normalcy that so many predict has the rather alarming aspect of creating a sense of complacency that will only serve to “kick the can” down the road.

This week we look at the problem, and then muse upon what the more likely scenarios are that may play out. This is a longer version of a speech I gave this morning to the New Orleans Conference, where I also offered a path out of the problems. This letter will be a little more controversial than normal, but I hope it makes us all think about the very serious plight we have put ourselves in.

Let’s review a few paragraphs I wrote last month: “I have seven kids. As our family grew, we limited the choices our kids could make; but as they grew into teenagers, they were given more leeway. Not all of their choices were good. How many times did Dad say, ‘What were you thinking?’ and get a mute reply or a mumbled ‘I don’t know.’

“Yet how else do you teach them that bad choices have bad consequences? You can lecture, you can be a role model; but in the end you have to let them make their own choices. And a lot of them make a lot of bad choices. After having raised six, with one more teenage son at home, I have come to the conclusion that you just breathe a sigh of relief if they grow up and have avoided fatal, life-altering choices. I am lucky. So far. Knock on a lot of wood.

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Category: Think Tank

The American Enterprise Institute in Washington hosted this discussion on the steps taken by the government to stabilize the financial markets. In the first session, AEI resident scholar Vincent R. Reinhart presented his findings gleaned from a series of conversations with market participants. Angel Ubide of Tudor Investment Corporation; Greg Ip, the U.S. economics editor…Read More

Category: Bailouts, Regulation, Think Tank

TIPS, what they sayin?

With the persistent weakness in the US$, a 4% rally this week in the CRB index, much better than expected job’s data from Australia and Canada, a rate hike from the RBA, and a weak 30 yr US bond auction, inflation expectations in the 5 year TIPS has risen 11 bps on the week to…Read More

Category: MacroNotes

Employment Change by Industry

Huge info graphic, via Visual Economics: click for ginormous chart Hat tip Flowing Data

Category: Employment, Think Tank

Europe Markets

The European view is from a major trading desk morning comment, where the author cannot be cited:


European markets have come off their best levels this morning and are currently percolating just below the “unch” mark: DAX -0.2%; CAC -0.2%; FTSE -0.1%.

The miners are taking a breather after nice gains yesterday (Lonmin -1%; Xstrata -1.6%; Vedanta Resources -3.2%). Tech and financials are weak (although the weakness in the financials is more pronounced in London and Paris than in Switzerland or Frankfurt), while energy and industrials are weaker. My guess would be that European markets are a tad more rattled by Ben Bernanke’s comments than were the Asian markets. (Bloomberg)

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Category: Markets, Think Tank