We’re probably guilty of some sort of copy write infringement here. No, no-one here is expecting a new family addition. We’re speaking specifically of the much anticipated market correction and corporate earnings season. Having failed as of yet to receive the first, we are fairly confident of delivery of the second. Will they perhaps coincide?
The thesis of the “too far too fast” crowd is that stocks are now discounting a V-shaped recovery (yes, we know we promised no more consonants) to economic conditions that will not materialize. While we do accept that markets are discounting mechanisms we disagree as to what they are, in fact, discounting. As we write this, an incredulous TV talking head is complaining “how dare the stock market forecast the economy?” Well, Madame, that’s what it’s supposed to do!
Using the widely tracked S&P 500, stock prices right now are slightly ahead of where they were on Election Day 2008 and 11% below where they were on
September 15th, when Lehman Brothers declared bankruptcy. The index is still 32% below its peak, achieved in October of 2007. For our purposes we assume that we are more or less back to where we were on Election Day. Well, if one can remember that far back, we had already witnessed the collapse of Fannie Mae, Freddie Mac, Bear Stearns, Washington Mutual and Lehman Brothers. The Federal Reserve was forced to guarantee money market funds as some had already “broken the buck,” Congress had reluctantly approved $700 billion for the TARP and the 30 day T-Bill sported a negative yield (yes, you paid Uncle Sam to hold your money). We would argue that those were some fairly dire conditions with a correspondingly extreme negative market sentiment. Of course, things did get worse for stock indices, much of which can be attributed to deleveraging of hedge funds and headline risks from the opening shots of the Geithner Treasury. Nevertheless, despite the rapid ascent from March 6th, we are no better off stock-price-wise than we were when Obama was ahead at the polls on Election Day. That says to us that stocks are hardly discounting a rosy scenario; certainly not a return to pre-Lehman economic conditions.
So far September hasn’t lived up to its reputation (it’s not over yet) but a reminder that October is when most big crashes occur. So what can we expect as earnings season rolls around? Are investors expecting (and stock prices discounting) significantly improved earnings? Well, that’s a big debate around here. So far Fed Chairman Bernanke has declared the end of the recession, the Purchasing Managers Index has crossed 50, signaling growth, and we have the 4th consecutive monthly positive set of Leading Economic Indicators. One would think, then, that investors will be expecting earnings to follow the positive economic news…or will they? Now that it is confirmed that we have hit bottom and are on the mend, there is still the potential that investors will give companies a “free pass” for missing expectations on the promise of better numbers to come. So, perhaps, what we should expect is not so much earnings reports as earnings guidance. Any downplaying of expectations, whether based on fact or well-intentioned sandbagging, may well engender the market swoon we have all so long come to expect.
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