Expect Disappointing Q4 Numbers
01/10/2013 7:00 am EST
While the numbers might not be getting stronger, the markets are in good shape to deal with another mixed quarter, notes Jack Adamo of Insiders Plus.
The first week back was a quiet one in terms of company news, but the market threw a wild New Year celebration over the settling of tax issues. Taxes are, of course, too high all around because of the inherent inefficiency and corruption of government, but within that context, the compromise didn't do too much additional damage. The only thing I saw that was glaringly missing was a repeal of the "carried interest" rule by which private equity firms get capital gains treatment on practically all their income, despite the fact that in a typical transaction only 3% is truly capital gains. We can only assume they make very large campaign contributions.
The flip side of all this is that our legislators punted on the whole issue of spending cuts. They postponed a vote on those for another two months, after which there's a good chance it will be another two months, then another, etc. Trying to make politicians cut spending is like trying to tell a five-year-old to eat less candy.
Market Looks Strong—Mostly
The unresolved political uncertainties are of a longer-term nature. Clearly, the market is not worried about them lately. We can observe that none of the major market averages seem to be suffering. The DJIA is near a post-recovery high. The worst that could be said about it is that the most recent bounce hasn't risen above the previous one yet, but with the recent low firmly above the prior low, there's nothing in this chart to make one think a new high won't soon follow.
Although I'm still skeptical of this liquidity-driven rally, if Q4 earnings show improvement, we'll start putting more money to work. Alcoa kicked off the earnings season on Tuesday, but most companies won't report for several more weeks, so we won't get a good read until the third or fourth week in January. Actual 10-Ks (full annual reports) won't be out until near March.
There are a few reasons why I'm hesitant to jump in until Q4 earnings hit. I just learned, yesterday, that S&P 500 earnings were in fact down for the third quarter. Those numbers were straight from S&P, not estimates. We did not hear this news from any big media outlet. The last report I read (about a month ago) said earnings rose 0.1%. Although that was noticeably worse than Q2 earnings, which were anemic enough with just a 0.9% rise, at least it was a positive number. The final verdict on Q3 was not.
Moreover, all these figures are "adjusted" earnings. Nowhere could I find a report on GAAP earnings, which were certainly down. The only question is how much. I've also been unable to find figures on revenue growth, which was probably negative too. It is easy to manipulate earnings, but the CFO risks jail time if he/she fudges revenue figures.
Estimates for Q4 are again rosy, although they've once again come down quite a bit. But while gains are expected to be muted, the Street is now touting the supposition that earnings will be at an all-time high. That sounds great. However, it would take only a fraction of a percent increase in year-over-year adjusted earnings to achieve that. Still, up is better than down, assuming the increase is real, not fabricated. What we'll need most is a realistic outlook from the conference calls. Are orders picking up? Are more pending sales closing? Those are the questions that require answers.
Fred Hickey is the best tech analyst I've ever seen. He expects Q4 earnings to be disappointing. With the exception of companies like Apple and Amazon, the tech sector has become as cyclical as the rest of the economy. If he is right (and he almost always is) we could see weakness across more sectors than the Street is expecting.
The last thing that has me concerned is the divergence in the Commodities Research Bureau index and the stock market.
Most of the time commodities and stocks move in tandem. That's because when the economy is healthy, demand for raw materials, etc., is strong and so are corporate profits.
The divergence from mid-2006 to mid-2008 presaged the biggest stock market crash since 1929. We are now 18 months into this second period of divergence. I wouldn't take this as an irrefutable stand-alone indicator, but together with the recent sharp drop in earnings and the length of the current cyclical bull, it certainly bears close watching.
Regardless of all that, we'll keep an open mind about Q4 earnings until the numbers tell us something definite. We've seen improvement in a lot of economic statistics with the exception of holiday sales figures, which were weak. Some of the broader improvements were undoubtedly helped by increased construction spending and vehicle replacement following Hurricane Sandy, but higher economic activity is usually good no matter how it happens. Now we will see if these improvements translate into higher profits.