Michael Barton

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Saturday, October 27, 2012

Earnings Disappoint Markets

Whilst economic data was mostly positive this week, with the European contraction slowing and US GDP pushing forward, news from the corporate sector was largely negative and it was this that focussed most investors’ eyes.

According to official figures, it seems that the Olympic fervour I the UK managed to pull its economy round and out of recession, After three quarters of decline, its GDP grew by a far stronger than expected 1% annualised rate of growth in this year’s third quarter. However, as if to mark the fragility of this data, and the wider economy itself, the news coincided with Ford’s announcement that it is to close two plants in the UK with the loss of 1400 jobs.

From the chilly north to the warmer south, where it seems that Greece’s next bailout instalment is under threat. Greece’s austerity measures are hitting the country hard, and it is currently encountering a worse than expected recession. Though Greece’s government has cut spending and raised taxes in efforts to bring its finances under some sort of control, it is two years adrift in its budget targets and has requested additional aid from the European Commission. The situation is so bad in Greece that there are stories of doctors who have not been paid their base salaries for two months and more.

Non-payment of commitments, however, is not a problem limited to Greece. In Spain, the Valencian region owes pharmacists around six months payments for health prescriptions honoured by those pharmacies. This amounts to around €600 million, and has been earmarked to be paid from emergency funds requested from central government.

Perhaps it is stories like these that have contributed to data that shows efforts to close budget deficits by taking severe austerity measures have been counterproductive. Indeed, where budget gaps have closed most, such as Greece and Spain, the ratio of debt to GDP has actually grown.

The impact of the territorial dispute between China and Japan is beginning to hit home. Japanese exports to China fell by 14% in September compared to a year earlier as the two countries continue to argue over a group of East China Sea islands. Hardest hit sector was automobiles which saw a near 50% fall in volumes exported from Japan to China.

The best economic news came from the US, which conversely saw some poor company reports. GDP growth in the third quarter came in at 2% annualised, following the first quarter’s 2% and second quarter’s 1.3%. Demand for durable goods in September rose by 9.9%, though the volatile aircraft numbers accounted for much of this increase. New home sales saw a further rise, and stand 27% higher than a year ago. With inventories near a record low, the new homes outlook is rosy. However, tempering the general upbeat mood, first came the announcement from the Fed that it sees a slow growth trend continuing with growth in jobs set to remain sluggish. Underscoring this view was the jobs report showing the four week moving average of jobless claims rising this week.

US company reports seem to fly in the face of economic statistics.

UPS saw a fall of 56% in its third quarter earnings as the global slowdown pushed revenue lower.

Caterpillar announced a magnificent rise of 49% in its profits for the third quarter, though revenues fell by 5%, but then said it sees sales and profits falling in the coming months: again blaming the global slowdown.

Apple’s profits rose by 24%, but this was less than expected. Some analysts are now beginning to question Apple’s product mix, with its revenues and profits so reliant on just the iPhone and iPad.

The giant chemical company, DuPont, said its revenue fell 9% in the third quarter and its net income fell through the floor. It also announced a cut of 1500 jobs, or 2% of its workforce.

Over the week, the Dow Jones Industrial Index fell by 1.8% to close at 13,107.21, and the S&P by 1.48% to 1411.94. The Nasdaq 100 also fell, but by a more modest 0.46% to 2665.83, while over in London the FTSE fell by more than 1.5% to close the week at 5806.70.

Trading View

I’ve been saying for some time now that it will be corporate profits that will dictate the direction of the market in the months to come. Investors are becoming used to hearing negative economic reports, and these are largely ignored with positive reports held as proof of the impending global upturn.

Try telling the Ford workers laid off this week in the UK that the economy is out of recession. Then head over the pond to DuPont, and tell its sacked workers that the economy is looking great.

We are now clearly approaching a time when slowing and falling company earnings will dictate company policy, whether that is to cut staffing levels further (how else can costs be cut now?) or to raise end prices to the consumer. Both scenarios are bad for the economy. It is my firm belief that the US economic numbers are being massaged as we move into the election, and that revisions to growth figures are likely to be seen after administrative change (or not as the case may be).

On top of these issues is the Fiscal Cliff now rapidly approaching: I may be the eternal bear, but I see very little upside to this market from current levels, though the downside risk is substantial.

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