Will New Fed Chief Love Printing Presses More Than The Old One?

Companies in key stock indices have started to report their corporate earnings for the third quarter of this year. Not surprising, they are weak and show signs of stress.

According to FactSet, up until October 4, 90 companies in key stock indices like the S&P 500 issued negative guidance about their third-quarter corporate earnings per share. This is the highest number of companies posting negative guidance since the research company started to track earnings guidance back in 2006. (Source: “Earnings Insight,” FactSet, October 4, 2013.)

The corporate earnings growth rate for the S&P 500 is expected to be about three percent in the third quarter, and just like the last quarter, once again, a significant portion of the boost in earnings will come from the financial sector. If you take the financial sector’s corporate earnings out of the equation, earnings growth rates drop down to about 1.7%. Take away all the stock buyback programs public companies have conducted this year, and the earnings growth picture gets really ugly.

I think the smart money is sensing companies are struggling to grow, so they are starting to pull money out of the market.

According to the Investment Company Institute, for the week ended September 25, the long-term U.S. stock mutual funds had a net outflow of $3.8 billion in capital. Similarly, for the week ended October 2, the net outflow continued and increased to $4.12 billion. (Source: Investment Company Institute, October 9, 2013.)

Key stock indices like the S&P 500, Dow Jones Industrial Average, and the NASDAQ have shed some gains recently; they are much lower than their all-time highs posted just this past September. At a certain point, the stock market will have to recognize the fact corporate earnings growth is fading. But as long as monetary policy is so robust, helping big banks and the stock market, the mirage remains.

The stock market is obsessed with the government spending more and more and the Fed creating new money. We saw it this summer when stock prices dove after Ben Bernanke just uttered the word “tapering.”

But have no fear, dear reader. There’s a new Fed Chief coming to town—and my bet is she loves running printing presses even more than the last guy.

[Even long-standing growth companies are feeling the pinch: YUM! Brands, Inc. (YUM) earned $0.33 per share in the third quarter ended September 7 of this year, compared to $1.00 in the same period a year ago—a decline of 67%. The CEO of YUM! Brands, David C. Novak, said, “Our revised full-year EPS outlook is obviously well below our 11-year track record of double-digit growth through 2012.” (Source: YUM! Brands, Inc, Third Quarter Earnings Press Release, October 8, 2013.)]

Michael’s Personal Notes:
In 2010, on average, for every one dollar in sales posted by the S&P 500 companies, $0.135 came from Europe. In 2011, this number declined to $0.11. In 2012, sales from Europe accounted for only $0.097 for every one dollar of sales generated by the S&P 500 companies. (Source: S&P Dow Jones Indices, August 2013.) These statistics should not be taken lightly.

The debt ceiling fiasco and the U.S. government shutdown are front and center now. Europe has been pushed to the back of the stage in spite of the fact that continued troubles there will have a negative impact on the S&P 500 companies.

Even though there has been growing optimism towards Europe, the region’s troubles are staggering. Unemployment in the common currency region of Europe remains ridiculously high. Bad debt is everywhere, and economic uncertainty remains high.

England, one of the biggest economic hubs in Europe, looks to be stalling once again after seeing menial growth. British industrial output declined 1.1% in August. This was the biggest drop since September of 2012. Output in the manufacturing sector fell 1.2% and other sectors, such as pharmaceuticals, electronics, and food and beverages, witnessed a decline as well. (Source: Reuters, October 9, 2013.)

So if Europe is far from being “out of the woods,” where will the S&P 500 companies get sales growth from? Growth in the U.S. economy is almost nonexistent and the Chinese economy is slowing, too.

Europe is an integral part of the global economy. The longer it takes for Europe’s economy to recover, the more scrutiny there will be on the revenues of S&P 500 companies. In the third quarter of this year, revenue growth for the S&P 500 is expected to be 2.6%. In the second quarter, it was three percent. (Source: FactSet, October 4, 2013.)

Sure, the S&P 500 companies can buy back their shares to make their earnings per share look better, but they can’t fudge revenue growth.

When revenues start to decline and the financial engineering stops working, S&P 500 companies have to take the necessary steps to keep profits from going down—meaning more job cuts and larger cash hoards. How can this economy ever grow under those conditions?

What He Said:

“As investors we need to take a serious look at our investment portfolios and ask, ‘How will my investments be affected by an American grown recession?’ You should take what precautionary steps you can right now to protect yourself from a recession in 2007. Maybe you need to cut your own spending or maybe you need to sell some stocks that will take a beating during a recession. You know what tidying up you need to do. Don’t procrastinate…get to it now. And please remember: Recessions can happen quickly, stock markets don’t go up during recessions, and the longer the boom before the recession, the longer the recession. Just based on my last point, we have plenty to worry about in 2007.” Michael Lombardi in Profit Confidential, November 13, 2006. Michael was one of the first to predict a U.S. recession, long before Wall Street analysts and economists even thought it a possibility.

Disclaimer: There is no magic formula to getting rich. Success in investment vehicles with the best prospects for price appreciation can only be achieved through proper and rigorous research and analysis. The opinions in this e-newsletter are just that, opinions of the authors. Information contained herein, while believed to be correct, is not guaranteed as accurate. Warning: Investing often involves high risks and you can lose a lot of money. Please do not invest with money you cannot afford to lose.

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