Posted on 06/22/2002 11:09:09 AM PDT by arete
NEW YORK (Reuters) - Trying to explain the current state of corporate earnings is like catching wisps of smoke: You close your fingers around them, but when you open your hand, nothing is there.
Such is the problem the stock market has been struggling with for the past year. The last few quarters were supposed to be the most brutal for U.S. companies, but then things were expected to ease up. No doubt about it. Yet the turnaround is still not in sight and investors are waiting.
The disillusionment over corporate profitability is massive. Fifty-one percent of 280 fund managers who oversee $711 billion in assets said in a Merrill Lynch survey that U.S. earnings are the worst in the world when it comes to predictability, volatility and transparency. Not seeing any improvement any time soon, the managers say the U.S. stock market is the one place where they most want to be underweight.
Many investors have thrown in the towel after five consecutive quarters of sub-par results, even as the crystal-ball readers are now saying the current quarter will "definitely" be the one that sounds the all-clear.
What's happened is the spring selloff in stocks has sent a message: Wall Street is bracing for the truth that the last six months of the year may be as tough as the first half.
The market got hammered because a lot of people bought into the rosy scenario that things could only get better and the bull market would get back on its feet after two straight years of losses. As the economy pulled out of recession, corporate profits would claw back, so the optimists thought. It hasn't happened.
Veteran Wall Streeters say the market remains in the dog house because it's still sorting out the crazy imbalances created during the bubbles of the 1990s.
Investors are discovering that the economic rebound has not translated into richer earnings. And the market's tumble has blown a big hole in investors' confidence after destroying a lot of their wealth.
Yet some investors are still hanging on to the idea the tide is about to turn. But the reality is that tide is going out rather than coming in, as it would in a bull market.
Of the 30 stocks in the Dow Jones industrial average, a startling 18 are in a downtrend and 10 are neutral. Only two stocks are in major uptrends: Johnson & Johnson, the health-care products maker, and 3M, the coated adhesives manufacturer, says James Dines, publisher of the Dines Letter, a financial publication.
DIGGING THE DOW FOR THE TRUTH
"This is classic deception," he says. "People superficially look at the Dow and do not dig deeper to comprehend its underpinnings, especially since the two stocks in an uptrend are not exactly cheap, based on historical measurements of earnings."
U.S. Treasury Secretary Paul O'Neill, for one, does not understand what's really happening.
Last weekend, O'Neill wondered why stocks were still in a bear market.
"I don't know why markets are where they are today," he said at a meeting of finance ministers from the Group of Seven industrialized countries in Halifax, Nova Scotia. "Eventually (stocks) will go back up, perhaps sooner than later. There is an unbelievable movement in the market without what I believe to be substantive information."
There was just one big problem. For the millions of investors who have gotten poorer in the last 2 1/2 years, O'Neill appeared to be putting a far-fetched spin on a market that has gone from ugly to spectacularly ugly.
The record shows Wall Street can be trusted for pricing in present and future economic activity. Stocks tumbled in 2000 and 2001 in anticipation that corporate results would be lousy. The market continues to slide in the absence of a shift in earnings growth.
Another historical fact is that the bear market will end only when there's a belief that quarterly earnings have sunk to a clear bottom.
Until then, people will have to start settling for more earthly returns for their stocks after the spectacular gains in the 1990s. The leading stock indexes are now at or near lows for the year.
For the second time this year, Standard & Poor's Investment Policy Committee told its clients to cut the stock portion of their portfolios and to increase cash holdings, saying it expects stocks to remain under pressure into the summer.
There's a disbelief that things will suddenly get better overnight because the economic and stock market performances are decoupling.
LESSONS OF THE PAST ARE NOT WORKING
The notions that major market selloffs are always followed by sharp recoveries and that corporate profits have traditionally rebounded sharply in the aftermath of major declines are not working in this down cycle.
The drop in corporate profits last year almost matched the 50 percent crash of the Great Depression, which should have set the stage for a tremendous recovery from such deeply depressed levels.
The surest bet is that optimism will set in once the earnings news starts to improve. Few factors are more basic in boosting stocks than companies making money. For now, the market is wisely discounting the current deterioration, just as it fairly priced in the awesome increases in corporate profitability in the late 1990s.
Not to be ignored is that as stocks continue to lose ground, the weakness will cut further into companies' pension funds. In other words, their stocks will no longer contribute as much to the firms' earnings through what the Street calls "recapture." Sounds more like Corporate America may be held captive by its own stocks.
Corporate earnings have been on a downward slope for more than a year and the steady drumbeat of warnings by CEOs of sub-par results are unnerving investors.
The unrealistic assumptions about the economy and corporate profits have puffed up valuation. The price-to-earnings ratio of the 500 companies in the S&P index (net earnings looking 12 months forward) is more than 30 after rocketing to an eye-popping 40 recently, according to Thomson First Call. The smart money says it's not smart to fool around with stocks when they are so highly valued.
It's also hard to make a bullish case after Morgan Stanley, a leading brokerage house, this week cut its second-quarter as well as 2002 and 2003 revenue forecasts for a benchmark company like International Business Machines Corp.
Then there's the brouhaha over corporate accountability, which has created a crisis of confidence and curbed investors' appetite for risk. The stocks of companies that have had their accounting practices called into question have been slaughtered.
If the Conference Board ( news - web sites), a business research firm, is to be believed, people have reason to stay on the sidelines. A survey of corporate ethics officers taken after the Enron mess made the headlines, found they expect at least six more major scandals in the coming year that will each wipe out more than $200 million in investors' wealth.
Many investors who played the numbers and lost are stepping back to get a better look of the environment after the market jumped ahead of its fundamentals late last year. The rally eventually broke down in early March.
Back in mid-January, Dines predicted that stocks would lock into a "scary selloff, escalating to terror by around June." Yet, people are still not convinced there is a risk in staying in the market.
"It is now June and the public is finally getting scared, although not scared enough to sell," he says.
For the week, the S&P 500 lost 1.8 percent to 989, the Dow average lost 2.3 percent to 9,254 and the Nasdaq slid 4.2 percent to 1,441.
Escalating into terror -- humm.
Richard W.
Richard W.
That would put the S&P 500 at around the 690 to 740 level. That sounds about right. You must have put some thought into coming up with that number. I "guessed" the S&P would drop to 800, but I've always leaned a bit to the optimistic side.
Richard W.
I totally agree with that statement and have been saying so for a long time. The economic boom was a fraud cooked up by Rubin in order to further a political agenda. Common sense -- give them a good economy and make them "feel good" and you can get away with about anything. As a plus, Rubin made many of his Wall Steet friends filthy rich.
I disagree that the government's (Fed/Greenspan) interventions in the stock market haven't been working. Except for this past Thur and Fri when they stepped back because of triple witching, they have managed to step down prices and prevented a meltdown type crash. I think that is their goal -- they don't want 2" headlines at the top of every newspaper declaring a market CRASH.
Investors are paying a high price now for previous excesses. Not much GW can do about it. In his own words, "We're going to play the hand we were dealt." That is the reality and we are going to have to deal with it. Things have changed.
BTW -- next time I expect you to tell us what you really think.
Richard W.
You were right on target with your IBM call. I think that you made it when it was still over 80. Wonder if it is too late to short it. Then again, if I did that, the DOW would probably run back up to 10,000.
Richard W.
Me also for a few years now.
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