I spoke with Jim Welsh yesterday — he writes the The Financial Commentator out of Carlsbad, California.
His views of the overall earnings situation intrigued me (they are somewhat similar to my own). Jim notes that not only is the energy sector disproportionately helping the SPX, but so are advantageous currency exchange rates and low interest rates — situations unlikely to persist as the year progresses.
Jim was kind enough to give me permission to reproduce his research/commentary here:
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Cyclical Bull Market to End This Year
JANUARY 24 – A number of factors are likely to weigh on
the economy, especially in the second half of the year.President Bush will attempt to make good on his pledge to
reduce the budget deficit, which means the economy will receive less fiscal
stimulus in 2005.Monetary policy is also going to be more of a drag. Changes in
monetary policy take six to 12 months to impact the economy, so the rate hikes
that started last June are just now beginning to bite.Since rates started from such extraordinarily low levels, the
drag will be modest, at least initially.In addition, 5-year, 10-year, and 30-year Treasury yields have
not risen, even as the Fed has raised short-term rates from 1% to 2.25%.As a result, they remain quite low and supportive of the
economy. However, as the Fed continues to raise rates, the drag on the economy
will progressively increase going into 2006.As the economy decelerates, corporate profit growth will slow.
In 2004, financial-related companies generated about 40% of total corporate
profits. Even companies like General Motors and Ford derived almost all of their
2004 profits from their financing arms.As interest rates climb further, it will be a tougher operating
environment and profit margins are likely to be pinched.Corporate profits were also bolstered in 2004 by the surge in
oil prices, which provided oil companies a profit gusher.Crude oil prices will not rise by 50% in 2005, so profits for
oil companies won’t grow as fast.And international companies saw their bottom lines boosted by
the decline in the U.S. dollar. If the dollar rallies in the first half of this
year, as I expect, earnings growth of international companies will slow.This suggests that the cyclical bull market that began in
October 2002 will end in this year’s first half.
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Source
Jim Welsh
The Financial Commentator
3578 Camino Arena
Carlsbad, CA 92009
(760) 436-3574
http://online.barrons.com/article/SB110666594658935253.html
Boy is this guy smart!!
…and humble!
Oil prices may not rise 50% in 2005, but remember that WS hasn’t fully embraced the new energy paradigm (whatever it is and turns out to be). If oil companies (E&Ps, integrateds, trusts) are currently valued against $30-$35 light sweet crude, and the price per barrel rises/stabilizes between $50 and $60 this year, and existing losing hedges expire, and, and…well, you see the point.
We may still be in store for another stellar year wrt earnings growth (as losing 2004 hedges expire and the bottom line improves accordingly) and capital gains (as WS begins to more fully embrace the sector)…
While energy may in fact be strong (and justifies significantly overweighting the sector) the broad market may have already peaked on a price basis, leading the back half 2005 fundamental deterioration. If so, energy may benefit from a rotation.
While consensus expectations for the market are modest this year, they may prove to be high. Just a few years ago I heard regular comments on the prospects that we were in a long-term range bound market; similar to the 1970’s. Apparently the rally has moved those folks off the front page. A quick look back at the 70’s and an overlay of this cycle for the DJIA hold striking similarities. The market break down at the turn of the New Year is consistent with post-election years in all four of the election cycles during the 70’s trading range from 1966 to 1982. Each of those years (1969, 1973, 1977, 1981)suffered negative January returns and closed down for the year.