Insights & Advice

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Will Earnings be the Tipping Point?

Midway through second quarter earnings season, many companies have surprised to the upside and their managements have changed their view of the future. On Wall Street we call it “guidance” and most of it sees a bottom or early signs of recovery in their businesses.

That coincides with our view. I believe we are experiencing the beginning of an economic recovery as you read this. That’s not to say that you personally will feel it anytime soon. No, this recovery will be slow (picture a long, shallow saucer shape period of growth) with anemic gains in employment.

Since I was in Dalton, at the Wahconah Country Club on Friday for a golf tournament we are sponsoring this weekend, I did a little testing of the waters in this area. Depending on the industry, the response I received from each individual was different indicating to me that this recovery is in its early stages and like life is uneven with some sectors doing better than others.

A banker from Cheshire told me most of his clients were afraid of the markets and would still rather stay in cash, earning little to nothing rather then risk investing in the markets. He had also just come from a banking conference where one of the speakers predicted that 50-80 banks were expected to fail before the end of the year. He also said that several builders of million dollar spec homes he knew in the area were “still sucking wind.”

A contractor was a bit more sanguine. Yes, he had laid off a few employees but business overall was “not bad, not good, just average but better than last year.”

A civil engineer, who owns his own company, agreed with me that the economy was beginning to turn. H explained that he was involved in the planning stages of all kinds of businesses from municipal parking lots to residential and commercial real estate projects to various infrastructure programs.

“I work on things six months ahead of other businesses so you could say I’m a leading indicator,” he said, “and right now business is bumping along, not busy, not slow but I’m expecting things to pick up later this year.”

As most readers are aware the stock markets usually begin to discount a recovery six months or so before the economy begins to turn. If so, the March rally off the bottom was a bit late but happened nevertheless. This second quarter earnings season, in its own way, also qualifies as a leading indicator of the economy and the markets. Of the various sectors that have reported thus far, two sectors stood out for me this week—banking and technology.

Some of the big banks like Goldman, Citigroup, Bank of America and JP Morgan reported better than expected earnings. Goldman Sachs’ earnings were so good that it moved the markets by several percentage points earlier this week. Don’t forget all the banks are still experiencing huge loan losses from sub prime mortgages, commercial real estate, bad loans, etc. but the accounting rules changed a few months ago. As a result, banks no longer have to subtract these losses from earnings. Yes, it is a lot like a “now you see them, now you don’t” shell game but it is what it is.

Technology, on the other hand, has been a bright spot among the lesser lights of industry. Their bottom lines are clean, simple and direct. IBM had an upbeat story as did giant semi-conductor chip maker, Intel. Even Google didn’t do too badly, although the markets expected more from the internet giant whose profits were up but sales slightly lower than expected.

As I explained in my last few columns, this earnings season would be crucial to the fortunes of the market and that proved to be an understatement. Only last week we were flirting with the bottom of the S&P 500 trading range at 875 and there was a real possibility the index and markets might break to the downside. This week, thanks to those earnings, we have had a complete reversal. With barely a pause to catch its breath, the S&P and other indexes have gained 7% in a week with the S&P just shy of its high for the year. The markets are now testing the upside limits of its trading range once again. This has been the story for the last two months. Next week more companies report and on the back of those earnings the market could either forge ahead to new yearly highs or pull back once again. Stay tuned.

Posted in A Few Dollars More, At the Market