Weekday Commentary from Jim Puplava
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"Let The 2002 Goodwill Games Begin!
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Jim Puplava's NEW Perspectives Series Market WrapUp for the Week
Monday l Tuesday l Wednesday l Thursday l Friday
Monday's Stock Market WrapUp
Reality Check
This week will begin a reality check for the earnings recovery so widely hailed by Wall Street for the second half of this year. This is where the rubber meets the road. Stock prices have been rising until recently based on an economic recovery that would be shortly followed by a return to profitability by corporate America. The week will be punctuated by a slew of corporate earnings announcements, economic data, and speeches by Fed governors, including the Big Kahuna himself, Mr. Greenspan. Everyone agrees with the assumption that this quarter will be another negative quarter of earnings comparisons. What happens next quarter is what becomes the new test ground for everyone?s forecast. When companies pre-announce their earnings for this quarter, analysts and investors will be watching what they say about the next quarter. When the first quarter ends this week, Wall Street believes we will begin to see miracles take place in corporate earnings.
First Quarter Results Coming
Analysts are still in the process of revising earnings down for this quarter. The current estimate is earnings will fall by 8.6%. That could change as more companies report first quarter results. Wall Street, however, which has been wrong for the last two years running, then expects a jump in earnings similar to the economic rebound following the last recession in 1991. Second quarter earnings are expected to rise as much as first quarter earnings will fall. The big miracles take place in the second half. By the third quarter earnings will be growing by over 30%, and then over 40% for the fourth quarter. The year is expected to end up as a double-digit barn-burner of 17.5%. Everyone is counting on earnings to bail out depressed stock prices.
This month marks the two year anniversary of the stock market peak for the S&P 500. Two years ago on March 24, 2000 the S&P 500 closed at 1,527. It hasn?t reached that plateau since. As of today, the index is down close to 26% from that level, with the index trading at close to 62 times recent earnings on a GAAP basis. The market remains overvalued by every benchmark and standard used for valuation because of bear market earnings falling faster than stock prices, leaving stock prices high by comparison. The hard part for Wall Street will be to sell investors over, hoping that the miracle in earnings materializes.
Analysts are keeping their fingers crossed that companies will start giving upbeat assessments during their pre-announcements for the second half of the year. Stock prices, which have now turned negative for the major indexes with the exception of the Dow, indicate investors aren?t buying the turn-around story. If companies don?t give upbeat reports for the next quarter, stock prices will then be in for a major readjustment. The one positive element for stocks has been the Fed?s aggressive easing in interest rates. Now that positive factor is going to be taken away with the Fed talking about raising interest rates. In addition to higher interest rates, energy prices are rising again with OPEC vowing to make no change in production until prices hit the $30 a barrel mark. These are the negatives that are now influencing stock prices.
However, the main threat to the stock market remains earnings. Wall Street has sold the investment public on the recovery scenario, the same recovery scenario they have been touting the last two years. If that doesn?t start to happen stocks are going to take a hit. There are already signs that equity managers are taking profits in short-term trades in fear of losing gains if the markets head south on bad news. First Call/Thompson Financial, which tracks analyst?s earnings estimates, believes analysts are still too optimistic in their profit forecasts. This could translate into analysts? revisions in the months ahead if companies don?t deliver the earnings that have been estimated. First Call thinks a 5% gain in pro forma earnings is more likely than the 10 to 17.5% estimated by Wall Street firms.
Losses Reported
That implies major readjustments are ahead of us. Many companies are already warning the Street that the numbers aren?t going to be there. McDonald?s lowered its first quarter profit estimates and its full year earnings on Friday. Several technology companies reported last Thursday that their losses would be larger than estimated, and that sales going forward were going to be weaker than originally estimated. As the number of these kinds of warnings increase, it is going to lead to major trouble for the stock market. The other problem is going to be the quality of earnings. Businesses are going to political war to stop any reform on to the way earnings and income are reported on the income statement. Accountants are fighting over giving up rich consulting contracts with their audit clients. Senators John McCain and Carl Levin are introducing a bill that would require companies to count option costs as an expense in accounting for payroll. The McCain bill opposition is being led by Senator Joseph Lieberman, who blocked reform legislation back in 1994. Accountants have Harvey Pitt, the head of the SEC, lobbying against restricting the big audit firms from the consulting business that has led to so many conflicts of interest as evidenced recently by Arthur Andersen. In the end, the battle will be won by those firms that have the best lobbyists.
The Perfect Financial Storm
The one positive factor for stock prices may be the Fed itself. There was a story in today?s Financial Times about how the Fed considered propping up stock prices if short-term interest rates didn?t revitalized the economy. In the minutes from its January FOMC meeting the Fed talked about taking an unconventional approach to rescuing the economy if it deteriorated substantially. If short-term interest rates failed to arrest an economic decline the Fed would consider a plan to buy U.S. stocks to prop up the economy. Fed officials were afraid a situation similar to what happened in Japan would evolve in the U.S. The scenario discussed would only be a last desperate measure to employ if the economy continued to deteriorate. This points to how important stock prices have become to the well being of the economy. Although this situation was avoided, it is on the table for the future if monetary and interest rate policy proves to be ineffective in rescuing the economy from recession. In effect, the Fed would liquefy the entire stock market. The Fed official who was questioned on the matter asked not to be named, but said the Fed "Could buy anything to pump money into the system, including state and local debt, real estate and gold mines-any asset."
Under traditional monetary policy the Fed relies on the buying and selling of Treasury bonds to affect short-term interest rates. If that doesn?t work in the future, the Fed may consider buying any asset class to monetize. This is a rather frightening thought when one considers the implication of these comments, or the fact that they are even considered. It would be tantamount to admitting the outright failure of monetary policy. The predicted outcome could backfire on the Fed with a complete loss of confidence in the financial system and in financial paper of all varieties. Under these circumstances, we would find ourselves in "The Perfect Financial Storm."
The Markets Today
The markets handed investors losses across the board on Monday with tech stocks taking the brunt of the damage. Within techs software, hardware and the Internet sector took a beating. In the broader markets investors were dumping airline, brokerage, biotech and retail issues. The only thing up was oil service, gold stocks, and natural gas. The Amex Gold Bug Index hit another record high today to close at 96.38. The index, first established in 1996, is up close to 48% this year. In the last 52 weeks the index is up close to 90%. The performance of gold stocks compares to the Dow and the S&P 500, which are up 2.6% and down 1.4% respectively year-to-date. Over the last 52 weeks the Dow is up 8.2% and the S&P is down less than 1%. You would think that analysts and anchors would notice this front-page news. Instead, they have chosen to ignore it and promote tech stocks that are still hemorrhaging with losses. Today AOL Time Warner announced its plans to write down a record $54 billion in impaired assets from its merger with Time Warner. AOL paid a whopping $124 billion for Time Warner. Today?s announcement of the $54 billion write off is an admission to shareholders, whose wealth was wiped out, that they overpaid for the media giant.
The price of gold is flirting with $300 an ounce despite desperate efforts by central bankers to knock the price down. The rise in gold may be signaling trouble lies ahead for the financial markets. The Fed has been dismissing gold and a weakening U.S. currency. Normally a weakening currency, a rising trade deficit, and an expanding government budget deficit is the kind of environment that drives up gold prices. During periods of monetary upheaval, gold performs well like it is doing now. This is causing central bankers to stay up late at night. Once people lose confidence in paper, which is what is happening in Japan right now, the confidence isn?t gained back easily. The Fed must be watching with horror at the financial nightmare in Japan. They could be looking at the very same scenario here in the U.S., which is why they may consider monetizing the entire financial system. The problem for the Fed is it won?t work, and it could cause the them to lose all of its creditability.
Investor gullibility is the best thing the Fed has going for it. Investor optimism rose in March to 121 from 92 in February, the highest level since November of 2000. Over 71% of investors now feel it is a good time to go long on stocks. Most investors polled in the recent investor survey now believe the worst is over for the U.S. economy. Contributing to that sentiment has been the recent run-up in stock prices. The little guy is voting with his pocketbook. Trim Tabs reports that $4.1 billion flowed into stock mutual funds in the latest week ending last Thursday. The little guy is buying at a time the pros are selling as pointed out in last week?s COT graph.
Volume came in at 1.05 billion on the NYSE and 1.41 billion on the Nasdaq. Market breadth was negative by a wide margin of 22 to 10 on the big board, and 22 to 13 on the Nasdaq.
Treasury Market
Government bonds ended mixed, reversing most of their early losses as equities deteriorated late in the trading day. The 10-year Treasury note recently erased 2/32 to yield 5.41% while the 30-year government bond climbed 5/32 to yield 5.80%. Tuesday will see the release of February durable goods orders and March consumer confidence.
Overseas Market
European stocks declined for the third day in four, led by BP and other oil companies as falling crude prices prompted investors to sell some of this year's best performing shares. The Dow Jones Stoxx 50 Index shed 33.78 points, or 0.9% to 3627.04. Vodafone, Volkswagen and Rio Tinto retreated after Credit Suisse First Boston advised global investors to cut their stock holdings.
Japan's Nikkei 225 stock average fell to a three-week low, led by Sony and other exporters on concern the U.S. Federal Reserve may raise interest rates, curbing demand from Japan's largest market. Nikkei fell 0.7% to 11,261.09. The Topix index shed 0.3% to 1073.20, with computer-related companies the biggest decliners as a group. NEC Corp. and other computer makers slumped after a report showed weekly personal computer sales at large electronics stores in Japan fell from a year ago, extending a 10-month slide.
© Copyright, Jim Puplava, March 25, 2002
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Weekly internet broadcast on Saturdays. Jim will discuss the week's Market WrapUp, The Big Financial Picture, Geopolitical News & Events, and provide an update on The Perfect Financial Storm. Precious Metals analyst, David Morgan will be our regular guest with commentary on commodities. Special guest experts complete the 2-hour broadcast. Tune in and tell a friend!