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binve (< 20)

Earnings and Equities: Diligent Cost-Cutting



September 19, 2010 – Comments (3)

In my last post The Big Picture: Technicals and Macro, one of my macro themes is that we had a failed inventory rebuild cycle. That is the "cycle" never took hold. The way an inventory cycle usually works is that businesses begin an inventory rebuild, consumers respond to the supply and real final sales pick up, businesses respond to the increase in demand and continue production, increase hiring, increase capex, etc. Throughout this "cycle" there has been a tepid increase in real final sales and the trend has been dropping significantly the last couple quarters. However the last few quarters earnings have been increasing. But there are two primary ways for earning to increase: a) organic growth based on a recovery (sustainable) and b) cost cutting / margin expansion (unsustainable). Notice what I said above, real final sales the last 2 quarters have been slowing considerably. Which means there has not been much of a). In fact most of the earning growth the last 2 quarters has been because of b).

Here is an interesting observation by Gary Shilling that goes very much along these lines. Businesses are still trying to cut costs. But they have already done the low-hanging fruit, which means there are not going to be huge gains in this category going forward. I still maintain there has not been significant organic and sustainable earnings growth and that this is at direct odds with current analyst's estimates. This is one headwind for expectations of signfiant equity price increases.

Another (detailed below) headwind is that in an effort to cut costs, employers are continuing to reduce / eliminate 401k plans. This means there will be less retail investor money in the market supporting equity prices. These two observations together are a double-whammy headwind to earnings and equity price increases.


The Chances of a Double Dip
By: John Mauldin | Sat, Sep 18, 2010

Diligent Cost-Cutting

American business has been diligently cutting costs since the recession started in December 2007, especially labor costs. A recent survey shows that over half of adults have been affected by some combination of layoffs, wage and benefits cuts, involuntary furloughs and involuntary shifts to temporary jobs. Many may never be restored to their earlier statuses. Those layoffs lucky enough to find new jobs often are paid less than earlier.

About 20% of major employers with over 1,000 workers cut or eliminated their 401(k) plan contributions during the downturn but half have failed to restore them so far. Of those with 500 or fewer employees that cut contributions, only 36% have reinstated them or plan to in the next 12 months, according to a Fidelity Investments survey. Furthermore, 10% of all employers plan to reduce or eliminate matching 401(k) contributions in the next year.

3 Comments – Post Your Own

#1) On September 19, 2010 at 10:15 PM, rd80 (94.66) wrote:

There is one dead simple, low hanging fruit cost cutting measure still available to many companies.  Replacing high interest debt with dirt cheap debt. 

Refinance is also an unsustainable form of debt reduction, but it hasn't run it's full course yet.  There are a lot of companies out there with good ratings and lots of higher interest debt on their books - VZ and T are two excellent examples.

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#2) On September 19, 2010 at 10:41 PM, MegaEurope (< 20) wrote:

Another (detailed below) headwind is that in an effort to cut costs, employers are continuing to reduce / eliminate 401k plans.

Employers have been reducing / eliminating their contributions to 401k plans, not the plans themselves. Big difference.

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#3) On September 19, 2010 at 10:45 PM, MegaEurope (< 20) wrote:

I agree with you, a lot of companies have scarily optimistic 2011  earnings estimates.  There will be some massive misses and downgrades over the next year.  Doesn't necessarily mean high quality stocks will go down though.

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