Over the past few years, I have noted (repeatedly) that despite record earnings (Quarter after Q of double digit year-over-year gains), increasing dividends, M&A activity and rich Share buybacks, stocks have been very rangebound. The analogy I favor is that each of those four items are an engine of a 4-engined plane. With all four spinning mightily, most indices are about where they were (give or take a percent) 2, 3, or 4 years ago. Only the Dow is above its 2,000 highs.
The danger of this four engined craft is that if any of the engines fail, the plane can be expected to lose altitude. Not crash into the mountains in a fiery conflagration, but seek a lower altitude before regaining stability.
The Earnings Question:
That process may be underway in the 3rd quarter. Despite the Dow reaching a record high (about 50 points from Dow 12,000 as I write this), both earnings and dividends are less robust than previous quarters. So far, we have seen increasing evidence that this Quarter’s earnings — as well as forward guidance — are coming in softer than Q1 or 2.
The WSJ reported that:
"The strong forecasted earnings growth is perhaps the single most important piece of evidence pointing to a strong economy in 2007," wrote Dirk Van Dijk, head of research at Zacks, in a note earlier this week. The ratio, which has fallen below one — that is, more companies issuing downward revisions, "is the canary in the coal mine, indicating that this pillar is perhaps not as strong as previously thought," Mr. Van Dijk said."
And, if Commodity & Energy prices remain depressed, the S&P500
will lose even more oomph. Those two sectors have accounted for a
disproportionate share of the 14% year-over-year gains of the SPX in
Q2.
The key question will be by how much. Psychologically, there is something significant about the y-y double digit gains. Let the SPX slide below 10% profit gains, and that will be a clear sign of decellerating economics — and trouble.
So far, earnings have been mixed. After the Alcoa/Genetech/Legg Masson misses, there were strong numbers from Pepsi and Costco. But it has hardly been consistent, and the forward guidance is less than robust.
Consider this short list of headlines grabbed from The Street.com Thursday night; It certainly looks like more downside than upside to me:
Don’t Miss
Centex Cuts Outlook
How this plays out over the next few weeks may be a function of forces beyond fundamentals. I suspect the strength we have been seeing will attenuate as we get closer to the mid-term elections.
~~~
Dividends Begin to Slow:
As Barrons noted last week, for the first time since their resurgence in 2003, dividend increases declined in Q3: According to Standard & Poor’s research of dividend data on
7,000 publicly traded companies, the number of payout boosts slid
in three of the past four months. July and
September suffered the heaviest declines. The drop was relatively small — increases fell 3.6% compared to the year ago period.
Barron’s quotes Howard Silverblatt, a senior index analyst at S&P:
"The slowdown…is quite disturbing, especially in light of the enormous expenditures on buybacks" noted . Silverblatt thinks the major question is whether buybacks are increasing at the cost of dividend hikes. He noted that October is usually a busy month for payout enhancements and that the approaching earnings season "will be a critical time to evaluate" the slowdown in boosts. Unlike dividends, announced buybacks don’t always materialize. (Even if they get started, they may not be completed.) In contrast, "dividend increases are a very big leap of faith that a company will have the cash flow to make the payments," Silverblatt asserted."
Consider the following data points regarding dividends:
• Companies in the S&P 500 are projected to spend ~$220 billion on dividends in 2006;
• That figure represents a 9% increase over 2005;
• Stock repurchases are up 12%, to $410 billion in 2006.
• For the first 3 Qs of 2006, dividend enrichments edged up 2.8% (compared with ’05’s initial 3Qs);
• Special (non-recurring) dividends advanced 19% in the 1st 9 months of the year, while reinstatements advanced 25%;
• S&P counted 14 dividend cuts last quarter — 75% more than a year earlier.Omissions dropped 21%, while 29 companies decreased their payouts this year; The total of "passed payouts" was flat.
The action in the market at present is a function of liqudity and momentum; It is not fundamentally driven.
As noted above, I suspect it will continue until the election . . .
>
Sources:
Real Downer: Number of dividend boosts slips in third quarter
SHIRLEY A. LAZO
BARRON’S October 9, 2006
http://online.barrons.com/article/SB116017755781585525.html
Lookahead: Earnings Await
DAVID A. GAFFEN
October 6, 2006 7:27 p.m.
http://online.wsj.com/article/SB116015819400785103.html
hello from germany,
what is most fascinating is that the market shrugged off the rebound in the yields from 4,50 or so to now 4,80 off.
barry i urge you to read the story from mish about
mike morgan vs cramer!
this is a classic. cramer pumped the builderstocks even after he spoke to mike morgan. this tells you really how crazy things are.
really a must read
http://globaleconomicanalysis.blogspot.com/2006/10/kool-aid-krispy-kremes.html
IMHO, a lot of people, especially some who post here regularly, make the mistake of trying to compare our current economic situation too closely to the past. In most past situations, an overvalued market sold off, became oversold (with single digit p/e’s), and rallied much later.
I think what is happening now is different. For whatever reason, there is enough support that the economy is catching up with the market. It may take a while for the market to move up again, and it’s quite possible that the multiplier will go south again (maybe if Dems take congress?), but the macro trend is a more or less stable equity market that over the next few years beomes more fairly valued.
Joshk
Everytime I hear “This time it’s different” I am inclined to batten down the hatches and to make an offer to sell to someone.
It is never different. Human nature is what it is. Markets are essentially moved by human behavior. (Over the long run).
You might very well be the canary in the coal mine.
Sure I could be wrong.
But if I run my credit cards up way high do I not owe the money? If I have to spend more for food and gas, does that divert funds that might be used for something else?
The lack of volatility is the biggest worry. It is like a spinning top. As long as there is enough momentum the top spins. But once it loses that momentum it’s behavior becomes erratic until it cannot sustain it’s upright spinning position and crashes.
I love to play the lack of volatility in a market. It means that there are few players projecting anything big happening in the future. So they stop looking too hard. Then something changes, a supply demand alteration, hedge/ mutual funds piling in or out and a directional movemnt occours. Then the players jump on it like there is no tommorow and there is an immeadiate and significent price change as expressed as a percentage. At that point depending on fundamentals and market excitment a trend may form. Then people get used to that……..
I’ve always liked this quote:
“History does not repeat itself, but it rhymes.” – Mark Twain
I agree that we have structural issues, and they are serious. But, I think we are solidifying at least on earnings.
Yeah, I have no idea who is going to pay SS/medicare/etc when the worker / retiree ration is 1.5:1, but let’s not dwell on those little bumps in the road. Whistling and walking away…
“As noted above, I suspect it will continue until the election . . .”
Ya think? It will be interesting to see what the TIO’s do post election.
http://fms.treas.gov/tip/reports.html
If you look back over the last 13-14 profit ‘peaks’ in the S&P 500 over the past several decades, you will note the index actually outperformed over the following 1- and 3-year periods.
That is, once earnings growth declined, stocks performed better than their historical averages. The market is a discounting mechanism, remember, Barry. It has likely already forecast the upcoming profit slowdown.
Gee, I am still waiting for dividends to skyrocket after the dividend tax cut.
>>>That is, once earnings growth declined, stocks performed better than their historical averages. The market is a discounting mechanism, remember, Barry. It has likely already forecast the upcoming profit slowdown.<<< Nice of you to remind Barry about that. I'm sure he forgot. So I guess it's all blue skies and apple pies from here on out?
Two things that may account for this market – the market has actually declined in value over the past few years if not in price. Look at an average p/e line chart and it shows a loss in value. Not at all surprising given the overvaluation we saw prior to that. Now look at the level of long term rates compared to earnings yield. You’ve got a earnings yield on stocks of about 6.4% – we’ve rebuilt the equity risk premium pretty strongly. I’m not saying the market is cheap, far from it actually, rather, the market is not anticipating a deep recession at this point. And, without a deep recession, the market is fairly valued with opportunities, even looking over a shallow valley.
jmf, thank you for posting a very interesting housing market article. It made for sobering reading….
That which shrinks
Must first expand.
That which fails
Must first be strong.
That which is cast down
Must first be raised.
Tao Te Ching, 36
Lao Tzu is short the market also ??
Well the talking heads at CNBC certainly are talking up the new highs and the earnings growth fundamentals…this afternoon they cited that we were in our 13th consecutive quarter of double-digit earnings growth for the SP500 and that so far 71% of company reports have beaten expectations (18% inline and 11% missed) according to Thompson.
Everything’s coming up roses.