The Standard & Poor’s 500 stock index closed on Friday September 24 at 1149. The index closed on Friday October 1 at 1146.
That’s a net move of 3 points in five trading sessions. For the past week stocks have been stuck in a rut. Spinning their wheels. As stagnant as Polka’s pond in August. (I played hockey there in the winter. In August you don’t want to know.)
For the first few days of this week I expect a replay of last week’s lack of net movement. But things will start to change on Thursday. That day brings the beginning of earnings season with a report from PepsiCo (PEP) before the market opens and from Alcoa (AA) after the market closes. And then on Friday the U.S. government will announce job and unemployment figures for September.
I’m willing to bet that even if you’re committed to torturing the data, you won’t be able to find much direction in those numbers. Alcoa simply isn’t the right company in the right industry to tell us how the economy is doing or what earnings season is going to look like. The unemployment numbers are moving so slowly that all they tell us is that they’re moving slowly. (Which is itself depressing this long after the official end of the Great Recession.)
Earnings season really starts to deliver the week after this with a report from Intel (INTC) after the close on Tuesday, October 12. Everybody will be waiting to hear what Intel says about the upcoming and critical fourth quarter and consumer buying (or lack thereof). That report will set the tone for the entire technology sector.
On Wednesday, October 13, before the open JPMorgan Chase kicks off bank earnings. Investors want to know if trading revenues at the big banks will be as bad as expected (and therefore depress earnings to the degree now projected.) But the really important trend to watch will be how fast credit quality is improving at banks. If consumers are falling into delinquency less frequently banks will be able to actually reduce their loan loss reserves—and that will be a boost to bank earnings. But a falling delinquency rate is also a critical precursor of any recovery in consumer spending. It’s hard to work up much enthusiasm about spending when you credit card has just been suspended. (For more on how earnings season could lead to a dip in the markets, see my post https://jubakpicks.com/2010/09/24/one-unexpected-thing-that-could-stop-this-rally/ )
So expect to see some movement in stock prices at the end of this week. But I’m afraid you’ll have to wait until the following week to see action that results in much net change in prices.
Going into 3Q earnings season, I expect earnings reports to continue to beat expectations across the board, albeit by a smaller number. If my memory serves me correctly, the number of companies which beat estimates in the last quarter was in the upper 70% range. I predict the number will be less this quarter, because the analysts have gotten smarter, removed the double-dip predictions, and begun to expect growth. That said, I wouldn’t doubt that CEOs are even more bullish than analysts and have deliberately low-balled estimates in order to more easily beat them when earnings are announced.
From a macroeconomic perspective, the trends I’ve highlighted in earlier posts remain intact. Corporations are still sitting on record cash balances, though they are starting to put that cash to use through acquisitions and capital expenditures. That trend has only begun. Another one is now underway. The bond-buying frenzy and low interest rates from the FED have made capital absurdly cheap. Retirees, baby-boomers preparing for retirement, and young people who shun stocks as a “roulette game” are funneling their 401k money and other savings into bond funds, forcing those fund managers to put that money to work by buying – you guessed it – bonds of all types. Corporate bond yields for good companies are at record lows. CEOs, having come to their senses to realize that the recession is over and that these low rates are offering a once-in-a-career opportunity to return money to shareholders, are seizing the opportunity and issuing bonds. Microsoft just borrowed $4.75 billion at 0.875% interest. So far this year, companies across the US have borrowed over $488 billion at similar ridiculously low rates. Here is an article from the NYT on the topic:
http://www.nytimes.com/2010/10/04/business/04borrow.html?pagewanted=1&=dbk&_r=1
This borrowing indicates several things. First, it indicates that corporations are betting on inflation, not deflation. The last thing you want to do in a deflationary environment is to borrow. Even if you can borrow at a low rate, it’s better to sit on cash and wait. On the other hand, if you expect inflation, you can borrow… the more the better. It also indicates that plans are underway to spend the money. If the business had no idea what to do with the money, they wouldn’t borrow. Better not to borrow, than to pay interest to sit on borrowed cash you didn’t need.
What are businesses going to do with the money? One thing they aren’t going to do is launch a massive jobs program. Companies exist to make money for their owners (shareholders), not to provide jobs for the unemployed. Most companies aren’t going to increase their cash flows or shareholder value by simply adding to their payrolls. Some may, but definitely not most. So I wouldn’t count on that. But I don’t think you need to wait for 5% unemployment to make money from this trend.
So what will they do? I think they’ll do exactly what they’re saying they’re going to do. Microsoft announced that it would be using its money to fund share buybacks. Other companies announced similar plans, as well as plans to fund new acquisitions and refinance debt. These strategies are going to directly enhance shareholder value. At a time when earnings are increasing and the economy is rebounding, the number of shares outstanding at major corporations will be falling. This is a recipe for rising share prices. I suspect that some companies may announce “special dividends” this year to distribute money to shareholders before new tax laws come into place next year. Others will be waiting to decide between dividends and buybacks once the tax picture is clearer. And soon, I expect that more and more companies will be using the money to launch new products or enter new markets.
Bottom line: eventually this money is going to find its way into the economy. Low interest rates from central banks in the developed world, coupled with bond mania, look to keep the accelerator on and easy money flowing in the short to intermediate term. Add to this the prospect of a controlled floating of the Chinese Yuan against the dollar within 12 months, and increased demand for materials and food in the developing world, and the prospects of inflation are looking greater and greater. This isn’t even considering a possible QE2.
What do you do as an investor? Own the big companies which are borrowing at these low rates, which have solid products with good growth prospects, and healthy free cash flow and fair dividend yields, Don’t short the market (except maybe select bonds), don’t sit in cash or bonds.
Doncha think the market has already priced in the likely earnings reports and will likely yawn.
But which way is it going to go???