After months of escalating concerns over European austerity plans, slowing of the torrid pace of growth in China, Japanese exports, volcanoes, oil leaks, sovereign debt crisis, financial stress tests, financial regulatory reform, horrifically bad calls in the World Cup, further weakness in housing here and abroad, rising jobless claims and a worsening jobs market, failure to expand economic growth in the US, and a potential poor earnings season, the market bounced. Investors had been overwhelmed by the sudden reversal of expectations since the April high. It seems almost hard to believe how different the market view has become since only three months ago. From January to April, the world markets were transfixed on the PIIGS, (Portugal, Ireland, Italy, Greece, Spain) and the high debt to GDP ratios. The Euro’s April intraday high was 1.3692. As Europe’s crisis expanded to nearly every nation and the stronger nations balked at helping bail out their neighbors, the crisis took another nasty turn. The Euro, serving as a proxy for the global opinion of the success or failure of the ECB and IMF to coordinate a financial rescue, fell to 1.1877. Last week, the Euro recovered a near perfect 50% of that decline (1.2785) before peaking at 1.2722 and fading back to close the week at 1.2641. The stability in seeing the Euro rally back and consolidate proved to be supportive of the US market, especially the Basic Material and Energy sectors, as they focused on the Dollar’s pullback.
The economic data were mostly below expectations, but after the housing data from two weeks ago, expectations started to decline more rapidly than the economy or consumer sentiment. The data on employment also started to weaken, but not nearly as fast as expectations. This soon translated into a downbeat forecast for GDP and earnings. A widely anticipated slowdown in the second half of 2010 suddenly became calls for the dreaded “double-dip” recession. However, that would require negative GDP numbers, which would be a far cry from the current 2.8% GDP estimate for Q3. Still, the cries were loud and resulted in a break of what many saw as major technical support at 1040 on the S & P. The pattern that has become more recognizable than the Mona Lisa, the dreaded “Head & Shoulders” top formation, provoked calls for 860 on the S & P 500. This would be the projection from the April high (1220) to the May low (1040), or 180 points down from the support at 1040. However, technical analysis is a little more complicated than a “pattern recognition” program on E-trade. The pattern did not meet the other characteristics of a Head & Shoulders top. Traders jumped to get short on the break, but all that pressure only amounted to a small dip to 1010. Short-covering was likely a factor in last week’s rise, but don’t brush aside the significance of the move.
GDP may very well come in shy of the 3.0% projection for Q2. May was weaker than anticipated and June was not much better. It was striking that the first quarter showed the beginnings of a small inventory rebuild. The regional Fed data supported this expectation with inventory data moving above breakeven in April. However, it became spotty in May and declined on a national basis in June. This means we may not get that component adding to GDP, or at least not adding as much as had been anticipated. This may also result in a shortfall in earnings in Q2 and Q3, but don’t despair. What we are looking at in these two earnings periods are profit margins and capital strength. Companies have been predicting this storm. Now we answer the question as to how well they’ve kept their costs down and improved the balance sheets. We expect great things from the cost side of the equation. We know companies were very conservative about adding to capacity, building up inventories, and even hiring new workers. In Q1, profit margins were at a record 36%. Anything above 30% would be the second best reading on record, so there is some room.
The balance sheet side of the equation is also remarkably important. Cash has been a much talked about topic. The S & P has estimated that the top 500 corporations are holding onto as much as $1.8 trillion in cash. Banks have set aside loan loss provisions of about $1 trillion. Companies have been hoarding their profits, not expanding, not hiring, not paying out big dividends, hiking buybacks, or getting involved in any M & A deals. They don’t need to borrow from the banks. With rates so low, holding onto cash is not a productive use of capital. However, it is the prudent move if the US were to slip into a double-dip recession. Looking beyond Q3 into Q4, anything short of seeing a recession will leave companies flush with capital to put to work. This is the catalyst for the next major bull phase starting in late 2010 or early 2011, depending on the severity of the current dip. This is not the end of an economic expansion like that we had seen in 2000 or 2008. Companies had become highly leveraged and had taken on huge risks. This time around, they are risk adverse and deleveraged. When investors recognize a bottom in the economy, it will signal the start of the next major bull market that should challenge 14,000. We’re obviously not there yet, but companies should be given credit for having been swift at moving to protect their balance sheets. This earnings season will expose the good and the bad.
Technology and Financials are the key drivers this week. Intel INTC (+0.7%), Advanced Micro Devices AMD (-0.4%), and Google GOOG (+2.4%) are set to report. Tech has been one of the sectors with the highest profit margins and highest cash hoards. Financials are also critical to any economic recovery. What JP Morgan & Chase JPM (+1.8%) and Bank of America BAC (+1.7%) have to say this week will give investors insight as to how solid the Financials’ footing is holding up. As earnings kick off this week, it will not be a slow start. The economic data may take a back seat to the tsunami of individual companies reporting, both big and small. That means volatility and a high degree for potential surprises. It should be an interesting week, but at least we’re starting the week with a cushion to the downside and the S & P 200-day moving average, flat at 1111.
After months of escalating concerns over European austerity plans, slowing of the torrid pace of growth in China, Japanese exports, volcanoes, oil leaks, sovereign debt crisis, financial stress tests, financial regulatory reform, horrifically bad calls in the World Cup, further weakness in housing here and abroad, rising jobless claims and a worsening jobs market, failure to expand economic growth in the US, and a potential poor earnings season, the market bounced. Investors had been overwhelmed by the sudden reversal of expectations since the April high. It seems almost hard to believe how different the market view has become since only three months ago. From January to April, the world markets were transfixed on the PIIGS, (Portugal, Ireland, Italy, Greece, Spain) and the high debt to GDP ratios. The Euro’s April intraday high was 1.3692. As Europe’s crisis expanded to nearly every nation and the stronger nations balked at helping bail out their neighbors, the crisis took another nasty turn. The Euro, serving as a proxy for the global opinion of the success or failure of the ECB and IMF to coordinate a financial rescue, fell to 1.1877. Last week, the Euro recovered a near perfect 50% of that decline (1.2785) before peaking at 1.2722 and fading back to close the week at 1.2641. The stability in seeing the Euro rally back and consolidate proved to be supportive of the US market, especially the Basic Material and Energy sectors, as they focused on the Dollar’s pullback.
The economic data were mostly below expectations, but after the housing data from two weeks ago, expectations started to decline more rapidly than the economy or consumer sentiment. The data on employment also started to weaken, but not nearly as fast as expectations. This soon translated into a downbeat forecast for GDP and earnings. A widely anticipated slowdown in the second half of 2010 suddenly became calls for the dreaded “double-dip” recession. However, that would require negative GDP numbers, which would be a far cry from the current 2.8% GDP estimate for Q3. Still, the cries were loud and resulted in a break of what many saw as major technical support at 1040 on the S & P. The pattern that has become more recognizable than the Mona Lisa, the dreaded “Head & Shoulders” top formation, provoked calls for 860 on the S & P 500. This would be the projection from the April high (1220) to the May low (1040), or 180 points down from the support at 1040. However, technical analysis is a little more complicated than a “pattern recognition” program on E-trade. The pattern did not meet the other characteristics of a Head & Shoulders top. Traders jumped to get short on the break, but all that pressure only amounted to a small dip to 1010. Short-covering was likely a factor in last week’s rise, but don’t brush aside the significance of the move.
GDP may very well come in shy of the 3.0% projection for Q2. May was weaker than anticipated and June was not much better. It was striking that the first quarter showed the beginnings of a small inventory rebuild. The regional Fed data supported this expectation with inventory data moving above breakeven in April. However, it became spotty in May and declined on a national basis in June. This means we may not get that component adding to GDP, or at least not adding as much as had been anticipated. This may also result in a shortfall in earnings in Q2 and Q3, but don’t despair. What we are looking at in these two earnings periods are profit margins and capital strength. Companies have been predicting this storm. Now we answer the question as to how well they’ve kept their costs down and improved the balance sheets. We expect great things from the cost side of the equation. We know companies were very conservative about adding to capacity, building up inventories, and even hiring new workers. In Q1, profit margins were at a record 36%. Anything above 30% would be the second best reading on record, so there is some room.
The balance sheet side of the equation is also remarkably important. Cash has been a much talked about topic. The S & P has estimated that the top 500 corporations are holding onto as much as $1.8 trillion in cash. Banks have set aside loan loss provisions of about $1 trillion. Companies have been hoarding their profits, not expanding, not hiring, not paying out big dividends, hiking buybacks, or getting involved in any M & A deals. They don’t need to borrow from the banks. With rates so low, holding onto cash is not a productive use of capital. However, it is the prudent move if the US were to slip into a double-dip recession. Looking beyond Q3 into Q4, anything short of seeing a recession will leave companies flush with capital to put to work. This is the catalyst for the next major bull phase starting in late 2010 or early 2011, depending on the severity of the current dip. This is not the end of an economic expansion like that we had seen in 2000 or 2008. Companies had become highly leveraged and had taken on huge risks. This time around, they are risk adverse and deleveraged. When investors recognize a bottom in the economy, it will signal the start of the next major bull market that should challenge 14,000. We’re obviously not there yet, but companies should be given credit for having been swift at moving to protect their balance sheets. This earnings season will expose the good and the bad.
Technology and Financials are the key drivers this week. Intel INTC (+0.7%), Advanced Micro Devices AMD (-0.4%), and Google GOOG (+2.4%) are set to report. Tech has been one of the sectors with the highest profit margins and highest cash hoards. Financials are also critical to any economic recovery. What JP Morgan & Chase JPM (+1.8%) and Bank of America BAC (+1.7%) have to say this week will give investors insight as to how solid the Financials’ footing is holding up. As earnings kick off this week, it will not be a slow start. The economic data may take a back seat to the tsunami of individual companies reporting, both big and small. That means volatility and a high degree for potential surprises. It should be an interesting week, but at least we’re starting the week with a cushion to the downside and the S & P 200-day moving average, flat at 1111.