Alcoa is infamous for having lousy numbers and missing its estimates, even Cramer came out today saying who cares about Alcoa, they have lousy numbers. Last quarter they had lousy numbers, but everyone else had great numbers, so what does this mean? To me, it means that Alcoa is the contrarian play since they beat their numbers and raised guidance. Although one analyst says he was not happy with the results as he thought they would guide higher and attributed last quarter’s beat to the airline and auto industries higher demand, basically he said the rest of the year would be weak. I have not looked through the company’s numbers because I do not own Alcoa and I do not want to own Alcoa, so why bother.
Alcoa had good earnings, at least good headline earnings, and CSX had good earnings, which is no surprise since the rail reports have been looking better, but I think we are in for some serious outlook shocks moving forward. All the initial signs are there as the economy is cooling off, frankly it was never that hot to begin with, as retail sales are not stellar, consumer credit is contracting and unemployment remains incredibly high. For some reason the unemployment aspect has become a new normal that most people are immune to, 454,000 initial claims last week was not good and a 466,000 4 week average is not good, in fact it is disturbing that more people are not concerned about this. Not to mention, unemployment benefits for some 3M people are about or have already ran out, not good at all for future earnings outlook, in my opinion, or maybe this fits into a V shaped recovery story somewhere along the way, I get confused nowadays.
One surprise last week was the news that Wells Fargo was closing down 638 stores that catered to non-prime, a.k.a. sub-prime, borrowers, I thought they got out of that business 2 years ago? The firm is expected to has a $.02 charge because of this closure which leads me to believe there may be more losses which led to the closure of the division, not a stretch, I know. Also considering that their pick-a-pay mortgage portfolio still looks terrible I think there is more to the story, but, frankly, with the suspension of mark-to-market accounting what does a bad loan really mean anymore? I will say even with the accounting gimmickry that a bad loan still impairs the balance sheet even if it ‘looks’ good in the reporting and over time a loss will catch up to the bank it is just a matter of how long. I also suspect that there is probably no more perfect quarters for the trading desks f Goldman and JP Morgan, my heart bleeds for them. What I am trying to say is that we might be shocked to find that financials do not perform as well as expectations and their outlook gets more cautious.
There is also technology which has been on fire for the past year, there is no denying that. Earnings have been fantastic and growth has been abundant for pretty much anyone in the technology arena, but will it continue? I fear, no. One of the dirty little secrets is the fact that for the bulk of the last years Asia has been the driving force of growth and these firms have had the benefits of a declining dollar which meant a lot of positive FX results. This is true for Google to Intel who all had several hundred million in earning kickers thanks to a depreciating dollar, but that trend stopped at the end of 1Q10 when Europe started to really catch on fire. I am sure 2Q earnings are going to be good, but guidance might not be as robust as many believe and there is now greater possibility for misses on the top or bottom line as well.
There is also Europe to contend with, I know, everyone says Europe is no big deal and the impact in the U.S. will be minimal. Well, the same people also said the sub-prime crisis was contained in 2007 as well, how did that work out for you? The fact of the matter is that 30% of the S&P 500 earnings are coming from Europe and they are going to stop spending as much, that is just a fact. This slow down will have an impact on earnings moving forward, how much? I do not know, no one knows which is why guidance will probably be more cautious this quarter. You may be saying, well Asia is growing like a weed and I will agree with you, but only somewhat.
I will say that the population in Asia will probably be more liberal with their wallets than businesses will be. China has a lot to contend with right now between property bubbles blowing up, banks worrying about capital requirements, loans becoming harder to come by, profit margins being squeezed by employees wanting higher pay, but their top importer, the EU, has a falling currency and the U.S. consumer is also not buying as much either. They probably are not going to be buying as much as they would be or had in the past. A good barometer of this is the Baltic Dry Index which has plummeted over the past few weeks. China is the reason why the BDI expands and contracts, for the most part, and it shows that China is importing less because they are uncertain or at the very least done stockpiling for now. I believe that means Chinese companies are not doing much capex right now, I could be wrong, but I just don’t see it happening.
The other thing I know people will rip me apart on is the $1.7T, or there about, in cash U.S. companies has on its balance sheets. Many believe all that money will be spent or used to hire, well, what planet are you living on? How long has that money been there for? 6 – 9 months maybe a year now? This is like the cash on the sideline argument, it doesn’t hold water. I agree that eventually that money will go to work somewhere, but not now there is simply too much uncertainty out there. These companies will not go out and hire people, why would they do that, they just fired them? They don’t hire people just to give people jobs, that what governments do. The bottom line is there is no end demand right now, all the evidence shows that as the consumer is deleveraging and so are companies.
That money is sitting on the balance sheet right now because firms are worried about what is going to happen. Most firms paid down debt and are preparing to hunker down for a bad business environment for a long period of time which is why they are not raising dividends to much higher levels or buying new equipment. There is simply no reason to invest right now when the current employee level and technology can met their needs which is the problem with deflationary depressions. Over time this may change, but given what we see right now and the sharp drop in the leading indicators, drop in retail sales, etc. companies are just going to hold that cash until they absolutely have to spend it. I hope I am wrong, but it doesn’t look that way.
I believe that we have plenty of reasons to be worried this earnings season. There has been tremendous technical damage done to the S&P and unless we get stellar earnings and good guidance I do not see the markets going higher. The headwinds are just too strong right now and there is little sign that things are getting better, the opposite is true. I believe we are heading for an immense P/E multiple compression and that is a good thing for value investors, bad for those who own AAPL though. Speaking of which, AAPL is also another reason to be weary of the market right now, it is the only alpha holding out there, take that bad boy out and it will be like trying to get an elephant through an eye of a needle. Plus, if AAPL broke the trust they have with their users who can the people trust? Look for lower guidance.
The pundits came out to spin retail sales numbers as being not as bad as they looked, etc. However, they are actually worse than they appear when we take a step back and look at the big picture at what has changed over the past couple of years. It is interesting that anyone is trying to spin the retail figures as anything other than horrible, but I guess when you are long only mutual funds you know where your bread is buttered and it is not in showing how bad the data really is.
CNBC, the ultimate spin machine, they should change their name to Spin Co., liked to point out that electronic sales were up as well as furniture sales. Well, how about that 2 areas that went up out of how many? We won’t mention that, but the negative list is much longer. Here is what is important to note, electronics went up because prices keep dropping, check your email for discounts from Dell and Best Buy, but the real story is the iPad. What would happen if we subtract iPad sales out of the mix? I am willing to bet electronic sales look less rosy than the headline figure and the point is, how long will the iPad continue to sell so well? Who knows, but probably for a while. As far as furniture sales, well, you got me other than I am sure the sales were rich and prices are still dropping.
The real story, what even I forgot to think about when the figures were released, is the fact that there is much less competition than a year or so ago. Best Buy used to compete against Circuit City and Comp USA, granted they were smaller players, but still they are facing less competition than they once did. How about all the mom and pop stores that are gone? There are far less companies vying to all this business out there and the players that are left have zero pricing power which is downright scary in my opinion. On top of all of this many of the large stores closed down their less profitable stores as well so we had consolidation from a competitive point of view and consolidation from corporate point of view and sales are declining.
While this is not good news for the bulls, there is no way to really spin this, it is really bad news for the economy as consumer spending is such a large part of our GDP. However, I do see some positive things happening, people are spending less on junk they simply do not need. Let’s face it, the iPad may be cool, but does one really need one? This means that the less people spend on all of this junk, hopefully, the more they will save. While this makes many of your cringe, this is a very good thing. As a country we need to save more and spend less which is counterintuitive to most people, but with a higher savings rate we might be able to start fixing some of our fundamental problems in our country, like GDP being some 70% of GDP. Basically, we need to save more, produce more and spend less.
As far as the other “bright spot” on Friday, consumer sentiment reached a 2 ½ year high of 75.5. Surely this is fantastic news and a reason to buy, buy, buy, but this number is still in recession territory and diverges drastically from the ABC Weekly Consumer Comfort Index. Of course polls are polls and will vary depending, but one thing is clear what appeared to be a huge upturn in the economy was a head fake. The data, most of it, is pointing towards another slowdown as the stimulus wears off. There is little political will to do another stimulus package, which is actually a good thing believe it or not. Things may get worse, but hiding problems are far worse than getting them out of the way.
It was funny to see many of the pundits spin bad data on the weather. This equates to my daughter saying the dog ate her homework. It is hard to believe the snow is to blame for higher initial jobless claims when we are in the middle of winter. However, I will concede that retail sales will be pretty horrible because of the weather, but other pieces of data, well, not so much of that weak data can be blamed on some snow.
Housing starts stink because the housing market is in trouble and even massive government stimulus is not helping. My guess is this data will probably improve in March to April because of the last minute rush to buy homes, but I would not count on that being much of a bump. What is worse is that the President wants a permanent moratorium on foreclosures which is doing no one any good and, in fact, will hurt banks that would not be able to collect or sell an asset that is earning them anything. I am referring to Obama’s demand that before a foreclosure can happen it has to pass through the re-modification process. Capitalism is officially being suspended until further notice.
As far as jobless claims are concerned, they are going to get worse as far as I can see. I am basing this on antidotal evidence of firms continuing to announce layoffs and a jump in the mass layoff indicator a few days ago. It is crazy to think employment will improve when you have blue chip companies announcing layoffs and claims are heading back above 500K a week. This is not because of the weather it is because the economy stinks. David Rosenberg calls this a Houdini recovery and he is correct. Besides a statistical recovery and a rally in equities, which is odd considering the dismal news over the past 2 weeks, the average person is worse off than they were last year. Again, unless it has been snowing for 8 months it cannot be blamed on the weather.
Perhaps it is snowing in Greece as well, that will explain their financial problems. It is true that the weather hurts certain things, but it has a rather limited impact on employment. After all, snow removal companies would probably be hiring. The weather might hurt retail sales, but with more people using the internet, me included, to shop I would not buy the soon to be claim that the weather killed retail sales. This is all about uncertainty in the world and to deny that there is uncertainty is simply crazy.
We have problems all over the place from domestic issues to possible sovereign defaults. Let us not forget we will witness municipal bankruptcies in the near future as well, chapter 9 is the more likely bankruptcy procedure. Health care reform is back and will be passed, whether you like it or not, and believe me you should be careful what you wish for because this means higher premiums for everyone. Do you really think Anthem raised prices 39% because they wanted to? Nope, it is because, I as speculated months ago, they know they are out of business in 4 years. All of these things mixed with tight credit conditions means tons of uncertainty.
Why the markets are not down 200 points, I do not know. However, it appears that Goldman Sachs was a huge buyer or S&P 500 futures yesterday, according to Zero Hedge reports, which made this a futures driven rally, check out the trading between 3 and 6AM for more weird futures action. I do not want to spread conspiracy theories, but all I am saying is the markets are trading very odd right now. I am still very bearish, how could anyone be bullish with the horrible data we have seen as of late? This is not 1 week of bad data, but 2 months worth of bad data and the market ignores it, weird.
I guess a few firms had to be to Scrooge given the 452K initial claims we saw this morning. Anyone expecting a larger number than we got is crazy because companies just do not or try not to fire people around the holidays. In fact, I am shocked that we saw claims as high as we saw today which reinforces my thought that the employment picture is not getting any better, I know I wouldn’t know a V shaped recovery if it hit me in the head because employment is a lagging indicator. That would be true for an inventory recession, but not for a credit collapse or do I have my type of recessions mixed up?
These initial claims and the ISM data is still not consistent with the magical -11K employment report we got in November, sorry for being a doubter. I simply do not trust government data and neither should you because the BLS along with this administration, any administration for that matter, will do anything to make themselves look better. For example, even though banks are not lending the BLS insists that 30K people started their own businesses in November, really, that is what the birth/death model says. Go back a year ago when things were really bad and the numbers are even higher, 100K+ people were starting their own businesses when the credit markets were frozen solid, so trust those BLS numbers all you want, I don’t.
To further illustrate this point, last month the BLS reduced the number of people in the work force by some 130K, they just took them out of the work force, why? Because they gave up looking for a job, or could not find one, and that is how you get a -11K employment report and massively revised prior reports. I wish we could all doctor our books like the government as we would all be rich. However, did you hear Steve Liesman tell you about how the BLS removed people from the workforce? Nope, you did not. Santelli told you about it and Santelli told you about how retail sales were doctored, but none of the other talking heads, why? I don’t have an answer, I really want to know why. I get that no one wants all bad news all the time, even I don’t want that, but I do want the truth.
My point is that last week and this week we will see soft initial claims numbers and December’s employment report will probably be OK, unless they doctor it up again. If they doctor the report, which will be unnecessary, it will be spectacular and completely unbelievable which will be the problem. Moving forward credibility will be an issue for the government, kind of like the USSR in the 1980’s when they said everything was fine and we knew it wasn’t, we are trying to do the same freaking thing. The thing is when 20% of the population is unemployed/underemployed, 1 out of 5 people, you cannot lie your way out of that and you will pay through the elections. This AM on Squawk even Liesman finally admitted that the Bush “economic recovery” was very poor and we are right where we were at the beginning of the decade. We need massive job growth, 300K+ a month now to turn this around and that is not going to happen.
The economy is bad and without government intervention there is no green shoots, period. The housing data yesterday proves that because that was the first look at housing starts without the tax credit, starts were down 11% when expectations were for +6%, ouch. That is quantifiable proof that the private sector is doing nothing right now and it is 110% government intervention growing the economy which has zero multiplier effect, it actually destroys wealth especially when your country has to borrow 100% of the money. That one data point on its own destroys the V shapers story, but if you combine it with any other data point it completely buries it. Let us not forget that if this was a V shape the Fed would have at least changed its language during the last meeting, but nope they did not even do that. Keep in mind I want out of this to, but I am just not delusional. Sure stocks are higher, but that doesn’t mean the economy is OK and in fact it means there is pain coming hard and fast somewhere along the way. Oh, where’s the volume?
Just how bad are things? Well, banks aren’t lending to the wealthy either. I spoke to a very wealthy friend of mine yesterday in Florida which is telling of what is really going on in the mortgage market right now. Now, I know how lending works, but there is simply no excuse for what he is going through right now in trying to refinance his condo in Florida, I know it is a hard hit area, but hear out the story before passing judgment. His condo was worth 7 figures before, but now in the high 6 figures and he has zero debt, $2M in cash, 790 FICO score and he is self employed. Now his self employed status is an issue because he has inconsistent income, $40K a year to $400K a year which is wild swings, but not bad considering he only wants to refinance $200K.
Here is the thing, he cannot get any financing from any bank anywhere. He wants to refi a portion of his condo, so it is totally secured, he has cash, credit, no debt and income with no bank wanting the business. Keep in mind I am not talking about a second lien where if he filed for bankruptcy the bank gets nothing, we are talking first lien here. So, how can this be if banks are ‘eager’ to lend, the credit markets are fully functional or the economy is just fine? It is not possible as this guy is prime to lend to. Now, if a bank is not going to lend to him, which is a collateralized loan I might add, then they are not going to lend to a small business or consumers in general.
All of this points to much tighter credit and much higher unemployment coming soon. Especially since banks are dumping TARP as fast as they can because they do not want to be told to lend by the administration or they want that one last big payday before the whole thing comes down. Actually, my belief is that why wouldn’t banks not want to repay TARP since they know they could get it back anytime they want. Either way, banks do not want to lend and they are not going. No lending, no growth.
This week should be fairly busy with market moving data points and bond auctions which will help gauge the economic recovery that we are told is happening now. The biggest data point, in my opinion, to watch is consumer spending which economists expect to grow at 50% of June’s rate. June delivered a ‘strong’ .4% increase in spending and July has a medium estimate of a .2% increase.
I have no idea which way the number will come in as the bar is set fairly low and people are out spending for back to school items. I believe there is a case for either an upside surprise or very dismal results. In general, I believe spending will continue to decline as unemployment appears to be on the rise again, but July may surprise us to the upside as sales and deep discounting of products is attracting consumers. However, discounted products squeeze profit margins and employers are getting more out of their existing workforce, mainly because people need to keep their jobs, but lower profit margins make it impossible to keep people employed.
The Case for an Upside Surprise
According to Bloomberg purchases, excluding automobiles, dropped .6% as of August 13th. They went on to say that retail sales slipped .1% in July which leads me to lean towards an upside surprise in consumer spending. Mostly because of pent up demand, we love to spend money, along with deep discounts and kids just a couple of weeks to get ready for their first day of school are a recipe for a surprise. Frankly, the ingredients are there for people to spend more as they are told the economy is recovering and stocks are up.
Perhaps June’s numbers were so bad because people where saving money for July and August to buy their kids new clothes. If that is the case then we definitely could have a, albeit short-term, surprise to the upside which will surely cause the market to add 100 or so more points to its overbought averages. If we do get an upside surprise I am sure it will be a one-off event as people really are hurting.
The Case for a Downside Surprise
While people are told things are better, they know better because they live in the real world and not in statistics. Unemployment has been creeping up over the last two weeks and many people have lost access to emergency unemployment benefits which means hundreds of thousands of people are absolutely broke. For those who are employed, their falling home value and massive stock market losses from last year make them feel especially poor.
Not to mention, their credit card bills just went up by 2% and they either closed some credit cards or the credit card issuer closed the account for them. Either way, they have less available credit to buy things which will and cash, frankly, is in short supply. However, the kids got to have the new Nike’s or Guess jeans or whatever is cool and obscenely expensive nowadays and who are parents to say no. There is also the likelihood that people blew their money on a new car with the cash for clunkers program. A surprise to the downside would mean that the Dow would probably come off a good 50 points as it, inexplicitly, does not go down now, ever.
The End Result
No one has any idea what the number has in stored for us and I am much more interested in the unemployment numbers that will be out Thursday. Contrary to popular belief, I believe unemployment is a leading indicator for our current problems as this is a credit led recession, unlike other recessions we have had in recent decades. I am sure that the markets will blow off any bad news and continue to trade in the top end of its current range. Frankly, the markets behavior make no sense to me as it is so overbought right now and, regardless of what they say publicly, no one has a real explanation for its rapid and sustained gains.
The really good news is that I have also noticed that the crowds picked up at stores in the last month which means they may be out spending money. However, I am willing to bet the average transaction size is much smaller than it was last year at this time. Either way the numbers come I am sitting out of equities with only 25% exposure, the risk/reward ratio is just not attractive, and am looking for a sharp decline in September or October when liquidity returns to the market. While I could be wrong on the timing, I am not wrong overall as the markets have 4%+ GDP growth and a lot of very, very, good news priced into it right now.
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