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As I've been saying, profits need to improve before we can see a sustained rally

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April 06, 2009 – Comments (12)

Bloomberg has a great article this morning that repeats what I have been saying for a while now.  Yes the stock market is a leading indicator, but until companies are actually able to grow and report profits the current rally will likely do little more than lead everyone who is hopping on off of a cliff.

The market has come too far, too fast.  Everyone is wishing upon a star and hoping that things will get better.  The rally has fed upon itself as investors who are afraid to miss out on the next big bull run have hopped on.  After losing more than half its value, the S&P 500 took only 19 trading days to rally 25%.  This is the fastest rise since FDR rolled out the New Deal. 

Ultimately at the end of the day it's earnings that drive stock prices and nothing else.  A sustained rally cannot happen until earnings begin to improve, or at least stabilize.  The earnings for S&P 500 companies have fallen for six straight quarters.  A Bloomberg survey expects this earnings decline to continue for at least the next several quarters. 

Companies begin reporting first quarter earnings tomorrow.  According the consensus estimate of more than 1,700 analysts, the earnings for companies in the S&P dropped by 37% in Q1.  These analysts are predicting that earnings will slide by 31% in Q2 and 18% in Q3 before rising in Q4. Uhhhh, I doubt it.  Even if earnings don't continue to gall as rapidly, don't expect them to soar either. 

Financials are going to have to help out in order for the S&P as a whole to show an improvement in earnings.  Despite showing some signs of life in January and February, both Bank of America and JPMorgan recently said that business wasn’t as strong in March. 

And the commercial property writedowns haven't even started yet.  The number of commercial property loans in default or foreclosure skyrocketed 43% in Q1 according to data from Real Capital Analytics Inc. show.  Commercial real estate values have fallen at least 30 percent since the 2007 peak and may drop 11 percent more this year, Frankfurt-based Deutsche Bank AG’s real-estate unit said in a March 25 report. 

This rapid increase in defaults will likely force major banks like Citi, BofA, and JPMorgan to increase write downs and loan-loss provisions on their commercial property loans, which they all are currently carrying on the books at 100% of their face value.

The statement by Stephanie Giroux, chief investment strategist for TD Ameritrade, in the article is right on the money.  She believes that:

The government’s plans to kick-start growth don’t guarantee a rebound in earnings and stock prices because consumer spending, which accounts for about 70 percent of the U.S. economy, will stagnate for years as Americans pay debts and businesses cut jobs.

Americans’ debts have remained near all-time highs even as they reduced spending, because people thrown out of work are depleting savings and tapping credit cards. U.S. household borrowing, which has ballooned almost 11-fold since 1980, equaled $13.8 trillion at the end of 2008, or 0.5 percent less than the record reached earlier in the year, according to data compiled by Bloomberg.

“You’ve taken a big engine of growth out of the system for a while,” TD Ameritrade’s Giroux said in an interview. “We are going to be confronted with sub-par growth as we dig out of this hole. The consumer has really driven growth in the economy, and the stock market is a proxy for that growth.”

Exactly.  I can't understand why more people can't see this.

S&P 500 Can’t See Enough Money to Feed Stocks’ Rally

Deej

12 Comments – Post Your Own

#1) On April 06, 2009 at 7:07 AM, maxhoffa (< 20) wrote:

i'm not so sure of that.

historically, the market has moved off the bottom and started to rise on economic indicators, signs of the economy starting to recover, rather than on the news of improved earnings which comes latter.

by the time earnings are improved, the economy as a whole has noticeably recovered, and stock prices have already traced up for some time.

if you wait for earnings, you've missed a lot of gain. of course we all now the risk of moving early. just a matter of what your risk tolerance is.

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#2) On April 06, 2009 at 7:17 AM, TMFDeej (99.41) wrote:

Thanks for reading, Max.  Perhaps I wasn't as clear as I should have been.  You're right that the market will move before real earnings improvement is seen.  However, I personally expect that the United States has entered an extended period of reduced consumer spending that could last for years as people delever and clean up their balance sheets and Baby Boomers pass their peak spending years.

I personally do not believe that corporate earnings will improve for a number of years not quarters.  To me, the risk of missing out on the next awesome bull market is much less than the risk of having the rug pulled out from under them when people realize that dramatic earningsimprovement will not happen for a long time.

Deej

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#3) On April 06, 2009 at 7:48 AM, maxhoffa (< 20) wrote:

that could all be true. the american will consume less . . . only questions being how much less and for how much longer? i think quarters, not years though. a lot of people are losing their homes and jobs . . . but a lot more are not. . things will be better, i don't buy '09 recovery, but i do buy '10 recovery.

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#4) On April 06, 2009 at 8:23 AM, Sigmar1 (< 20) wrote:

An excellent article, thanks TMFDeej.

Two points I feel people frequently overlook are:- 

 1) We cannot return to the previous levels of growth without another artificial bubble of similar proportions.  I have no doubt that one day such a bubble will again begin developing but not in the foreseeable future.

Therefore what we are currently seeing is not only a contraction but a return to a more sustainable normality. Spending will be less, employment will be lower and growth rates very low or flat when the economy stops contracting.

2) This brings me onto my next point, spending in Western economies can be much lower because so much of it is discretionary. A lot of the wants can be ignored or tolerated, only the needs must be met.

Personally, I'm hoping that this all prompts a new culture with new values that are less oriented around desire, consumerism and ownership.

The most shocking aspect of the whole debt fuelled over consumption / over production debacle is the willingnness of the powers that be to come to the aid of the least deserving. The finance industry truly has friends in high places. 

Sigmar 

 

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#5) On April 06, 2009 at 8:24 AM, Sigmar1 (< 20) wrote:

An excellent article, thanks TMFDeej.

Two points I feel people frequently overlook are:- 

 1) We cannot return to the previous levels of growth without another artificial bubble of similar proportions.  I have no doubt that one day such a bubble will again begin developing but not in the foreseeable future.

Therefore what we are currently seeing is not only a contraction but a return to a more sustainable normality. Spending will be less, employment will be lower and growth rates very low or flat when the economy stops contracting.

2) This brings me onto my next point, spending in Western economies can be much lower because so much of it is discretionary. A lot of the wants can be ignored or tolerated, only the needs must be met.

Personally, I'm hoping that this all prompts a new culture with new values that are less oriented around desire, consumerism and ownership.

The most shocking aspect of the whole debt fuelled over consumption / over production debacle is the willingnness of the powers that be to come to the aid of the least deserving. The finance industry truly has friends in high places. 

Sigmar 

 

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#6) On April 06, 2009 at 8:25 AM, Sigmar1 (< 20) wrote:

Whoops, sorry I double posted. Apologies, Sigmar

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#7) On April 06, 2009 at 8:40 AM, Entrepreneur58 (36.98) wrote:

Deej,

Its obvious that the economy would implode without gigantic stimulus in monetary and fiscal policy by the Feds.  One should not underestimate, however, the power the Feds have to give a shot of heroin to our junkie economy.   Enjoy the high while it lasts.

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#8) On April 06, 2009 at 9:08 AM, russiangambit (29.27) wrote:

> historically, the market has moved off the bottom and started to rise on economic indicators, signs of the economy starting to recover, rather than on the news of improved earnings which comes latter.

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Everybody is saying that but this is not what happened in the last recession, in the only one in the post-Internet age, where information spreads immidiately. We should pay more attention to that than to recessions that happened in 70s where government had pretty much full control of what was known. I have following theories as to why 2002 recession was different 1) fast spread of information fundamentally changed the behavior of market participants 2) the government was cooking the GDP numbers and the recession actually ended later than stated  3) the rise of retail investor changed the market dynamic where the market didn't truly go up until the retail investor got comfortable

Additionally, I don't really buy 100% into "the market is forward looking and market is efficient" theory. There is too much noise in the markets these days with instant access to information and rumors. Half of the time the market doesn't know the top from the bottom, the recent rally is a good example.

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#9) On April 06, 2009 at 10:54 AM, bigpeach (28.97) wrote:

Well, I disagree that the 2000-2002 recession should be looked at to predict stock market behavior. It was preceded by the largest stock bubble in US history. Stock values continued to decline after the economy had recovered because they needed to come down from excessive valuation, no other reason. Personally I do think the stock market is a good leading economic indicator, and if you wait for earnings to improve you've probably missed a lot of upside. A bit of informtion is below. I wish I could get historical quartely earnings for the S&P 500, but I can't seem to find them. Anybody know where I can get those going back 40 years? Here are the annual values for the last two severe recessions. Interpret this as you will:

Early 80s recession earnings:

1981 $15.18

1982: $13.82

1983: $13.29

1984: $16.84

S&P 500 top: November 1980 around 140

S&P 500 bottom: August 1982 around 103

Mid 70s Recession:

1973: $7.96

1974: $9.35

1975: $7.71

1976: $9.75

S&P 500 top: January 1973 around 120

S&P 500 bottom: October 1974 around 62

Earnings source: http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/spearn.htm

 

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#10) On April 06, 2009 at 11:04 AM, bostoncelitcs (42.29) wrote:

As I've been saying.......we need another "Depression".   We have gotten too spoiled.  No more bailing out companies with federal money!  Did Thomas Edison ask for a "handout"....did Bill Gates ask for a "handout" did Henry Ford ask for a "handout"............We built the Hoover Dam...We were the first on the moon!!

 

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#11) On April 06, 2009 at 11:05 AM, AnomaLee (28.58) wrote:

Fundamental S&P 500 Forward Price Projections [Link]

I just posted a link to that article[on SeekingAlpha] in my last post. It's interesting.

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#12) On April 06, 2009 at 11:51 AM, russiangambit (29.27) wrote:

> Well, I disagree that the 2000-2002 recession should be looked at to predict stock market behavior. It was preceded by the largest stock bubble in US history.

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I agree with you. It is not necessarily going to be the same patterrn as the last recession. What I was trying to say, perhaps, not very clearly is that past performance is not an indicator of future results. Sometimes market is forward looking indicator and sometimes market is just messed up like right now from all the government intervention. I just don't like it when people state a hyposis as a fact and follow it like it is a religion with complete disregard of what else is going around them and affecting their hypothesis at the core.

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