Mike Conlon
Senior Instructor
instructor@mywealth.com
In the midst of earnings season, the market is responding in typical fashion. In one of my previous articles from earlier this month, I talked about some of the things the market needed to see from earnings season in order to stabilize and move higher. Well, we’re seeing them. Now what?
As a result of the earnings “surprises”, the S&P 500 index (SPY) is at 8-month highs. But is anyone really surprised by these earnings announcements? The bar has been set so low in terms of analyst estimates that even the most inept of CEOs could guide his company over it. Is anyone else concerned about this?
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Apparently, Morgan Stanley’s equity strategist is. He says that investors should be selling into this rally as it has no legs. And one of the reasons that this rally “has no legs” is because companies are beating estimates even though they are experiencing declining revenues. The other reason that they are beating is directly related to unemployment. Let’s take a look at what that means.
Companies are becoming leaner due to mass lay-offs.
By reducing their labor costs, companies are able to increase their profitability even though they are not bringing in as much revenue. These companies include: Starbucks (SBUX), Ford (F), Caterpillar (CAT) to name a few. So is this a good thing for the economy and the stock market going forward?
Absolutely Not!
All this is showing us is that companies are good at cutting the fat so to speak, and not growing their business. This could be a sign that we are not out of the recessionary woods just yet. But what this is also doing is decreasing the amount of consumption out there as more and more people become unemployed and slash their spending. Also, it causes those who are employed to also cut their spending as well, as they are now fearful that they may be next in line to lose their job. So they start saving instead of spending.
So let the downward spiral resume. As decreased spending increases, companies will experience even smaller revenues, which will cause them to lay off more employees to remain profitable. Then Wall St. analysts will lower their estimates, which will allow even the weakest of companies to seem strong.
While the unemployment figures are declining more slowly from month to month, we are still experiencing huge jobless claim numbers and the employment picture does not appear to be improving.
I would have much rather seen companies not beat their earnings but retain employees, rather than slashing their workforce to gain a few bucks in their stock price. For the near-term pop in price they are experiencing will be short-lived, if there is no one left who can afford to purchase their goods because they are unemployed.
Unless that company makes government cheese.
So, if the equity markets can ride out this wave AND unemployment starts to improve significantly, then we can justify these current levels. If not, then I expect the equity markets to sell off (QQQQ, DIA, and SPY) and I will be looking at the US dollar ETF (UUP) to rise as the flight to safety trade will return.
I’m just hoping right now that the rest of the market doesn’t catch on, or that they’re too blind to see that these earnings are really forecasting bleak times, not prosperous ones.
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