Weekday Commentary from Jim Puplava
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A Shift to "Things" Seen in the CRB?
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6.8
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Market WrapUp for the Week
Monday l Tuesday l Wednesday l Thursday l Friday
Tuesday's Stock Market WrapUp
Companies Coming Clean
In just a few weeks companies are going to begin reporting their financial results for the second quarter. What may become more important than the earnings themselves is the quality of the earnings reported. Analysts and investors are hesitant to accept the numbers reported as fact. This next quarter’s numbers are going to get closer scrutiny after the myriad accounting scandals in the last few months. With the President and Congress talking about sending CEOs to prison for accounting fraud, the truth should be more forthcoming in the months ahead. Many companies that went on the acquisition path to drive earnings during the 90’s could become front line candidates for financial revisions. In addition to the acquisition minded companies will be those that used various accounting legerdemain to spruce up their numbers. Fearing shareholder wrath, an army of trial lawyers, and the thought of spending time in the pokey will help the numbers begin to resemble more of the truth.
Coming clean is going to have a major impact on the second half of the year. Right now analysts are widely optimistic over earnings prospects for the second half of the year. Estimates for the S&P 500 for the third and fourth quarter are looking extremely loony at this point. Estimates range from 40-48% gains in earnings, or what looks like an explosion in profits. One has to wonder what planet these analysts live on. There has been nothing said by companies reporting earnings in the past or what they say about the future that would indicate any gains about to transpire in the second half of the year.
In a study done by money manager David Dreman for the years 1982-1997, it was found that analysts’ earnings forecasts, on average, were triple the actual earnings growth of the S&P. What happens to the markets in September and October when companies start to warn about third quarter earnings? There is no way those earnings are going to show gains of 40-50%. There is simply no pricing power in this market. Companies are burdened with higher costs and pressure to keep prices down. The result is that profit margins have been slipping each quarter. In the case of automobile manufacturers, they have had to resort to zero percent financing again just to sell cars. In order to keep costs down on financing, many of these auto companies and leasing companies such as GE Capital are resorting to interest rate swaps to keep their borrowing costs down. What happens when interest rates begin to rise?
The point to understand here is that if companies are doing so well, why are they giving away product or laying off so many employees? You don’t layoff 10% of your workforce if things are improving. Last month layoff announcements rose 12% led by job cuts in telecom. Total job cuts announced in June came close to 95,000.
Another factor that could eat into profits this year is companies won’t be able to rely on pension contributions to help out profits. Many companies, such as IBM and GE, have made overly-generous investment return assumptions in the management of their pensions. This has allowed companies to use pension income and include it in their bottom line. Even though the company pension plan was loosing money, they were able to book profits by means of their generous assumptions. Now they may have to change those assumptions, and instead of adding income to the bottom line, they will have to make additional contributions, which will now subtract from profits.
Despite these pie-in-the-shy assumptions on earnings, analysts and investors still remain confident regarding future prospects for the market. Goldman Sachs investment strategist Abby Cohen thinks the stock market is undervalued now by 20%. Other Wall Street firms are still sticking to their forecasts for a positive year for the markets. Everything rests upon a second half recovery. Like last year and the year before, analysts are hoping the economy recovers along with the financial markets. The economy may recover, but if it does, it is going to be a profitless and jobless recovery. One has to wonder where these rosy forecasts are coming from; analysts either wear rose covered glasses, or live on the Street of Dreams.
California Legislative Alert
Speaking of the land of fantasy, back in the People’s Republic of California the state Senate just passed a $6.2 billion tax increase that will raise the tax burden on an average California family by $700. It was the second largest tax increase in the state’s history. The last time the legislature did this was back in the last recession. The huge tax increase drove many of the state’s largest employers out of the state. The spending cuts that are supposed to take place are mainly bookkeeping gimmicks that would rival Enron and WorldCom’s accounting methods. Some of the bills’ components include the following:
1. Raise taxes on gasoline by $0.50 a gallon
2. Taxing the miles you drive by two cents a gallon
3. Raising taxes on SUVs and minivans by $3,500
4. Reduce the speed limit to 55 miles per hour again; and
5. Require everybody to have a "tire check" certification
This bill has been passed behind closed doors and is now on our brilliant governor’s desk. This is the same brilliant governor that was so adept at handling our energy crisis. Maybe the state will pay for billboard sign that says, "Don’t come to California to do business or to live. If you do, we will tax you mercilessly."
In previous updates I warned with state spending budgets out of control and the economy in recession, states would embark on a major program of tax hikes. Yesterday was a 20-fold increase in cigarette taxes in New York City, and now we have Governor Davis’s run away spending spree that can only be supported by huge tax increases. When the tax increases fail to materialize as revenue falls, there will be more taxes increases until the citizens have had enough of the spendthrift government to start another revolution. California needs another Howard Jarvis.
The myth of budget surplus is gradually disappearing at both the federal and the state level. At a time of economic weakness, and at a time when corporate profits are disappearing and workers are losing their jobs, government can be counted on to do the wrong thing. They will keep on raising taxes until they kill the recovery, or whatever is left of it. At the national level, Tom Daschle and Dick Gephart vow to overturn the tax cuts of recent years once they regain control of Congress, which they hope to do this November. I have said it many times before; the government can be counted on to do the wrong thing at the wrong time, which is one more reason why I believe the "Perfect Financial Storm" is coming. Right now we are in the "eye of storm." It appears calm, but you can see the barometric pressure dropping and the storm funnel building everywhere you look.
Today’s Markets
The major averages slipped back into the red today. The biggest losers were the techs, with mostly Internet, semiconductors, and biotechs sliding. Even gold stocks fell today. Many mutual funds are reporting investors are starting to report redemptions. Brokers are having to make margin calls to their customers. Adding to the markets worries was a new warning coming from the FBI of possible terrorist attacks this July 4th. Another confidence shaker was a published report that federal prosecutors are preparing to charge a handful of Wall Street’s most influential Internet analysts with criminal charges. These charges stem from recommendations they made to the public while they personally disparaged the same companies. There was also was the spillover effect coming from France’s Vivendi. The French newspaper Le Monde disclosed the company tried to avoid booking a $1.35 billion loan transaction that would have increased the company’s balance sheet debt and pushed earnings into the red. Apparently, accounting scandals aren’t completely an American phenomenon.
We are coming close to the capitulation mark in the stock market. Today was a down day that was preceded by heavier volume of 1.81 billion on the NYSE and 1.88 billion on the Nasdaq. Market breadth was negative by 24 to 8 on the NYSE and 26 to 9 on the Nasdaq.
Overseas Markets
European stocks fell as a survey showed 50,000 businesses and consumers were less optimistic in June. The Dow Jones Stoxx 50 Index posted its worst loss in more than nine months as Vivendi Universal slid on concern the company won't be able to sell assets quickly enough to repay debt. All eight major European markets were down during today’s trading.
Japan's Nikkei 225 stock average rose, led by Honda Motor Co. and Toyota Motor Corp., after the yen had its biggest drop against the dollar in more than a month, boosting the value of automakers overseas sales. The Nikkei added 0.3% to 10,622.32.
Bonds Today
In the bond market, treasuries failed to extend Monday's rally. The benchmark 10-year note fell 3/32 to yield 4.79% and the 30-year government bond dropped 4/32 to yield 5.49%.
© Copyright Jim Puplava, July 2, 2002