Wednesday, October 21, 2009

Stock Market Hits The Point of Diminishing Returns

The markets keep rising, P/Es are going through the roof. Phil Davis, the options trader guru, had a really interesting take today on what is going on (I receive these reports and alerts by email daily).

Phil comments on the last Beige Book report which at the time it was issued on September 9th time he said the Dow was looking toppy at 9,650 and there was poor consumer confidence numbers (just like yesterday) and poor consumer credit number (no change) and the book had very little "good" news to report. Yet the market broke over 9,600 again that day and then took off all the way to 9,900 a week later. At the time, Phil was looking for any excuse to go higher on the hopes that "this earnings period will look like last one but have we now come too far, too fast?"
For today he says:

"It seems we are finally hitting the point of diminishing returns for earnings. Expectations have finally gotten so high that even big beats aren’t enough to keep the momentum going.
Last earnings quarter, we were down from 8,900 in June to 8,100 on July 9th as companies began reporting and we had a nice, 1,000-point relief rally over the first two weeks of earnings.
This time, we went up an additional 500 points in the past two weeks, over our 9,600 line and that has been in anticipation of a repeat of last earnings but the circumstances are very different this time and it takes a lot to justify a 20% run off the July lows. Keep in mind that, looking at the sector charts, Energy, Materials and Tech are leading us. Since semiconductors are simply another form of commodity - this is almost entirely a commodity rally in the midst of a recession with Consumer Staples, Financials, Health Care, Industrials, Telcom, Utilities and Transports all underperforming the rest of the S&P. As I keep saying - if no one is shipping anything, how the hell can we be having a proper recovery?

The Beige book is an anecdotal view of the economy gathered roughly through the middle of October and we’ve seen no improvement in Jobs since the Sept 9th report, Cash for Clunkers ground to a halt and, just this morning, we got a horrific 13.7% decrease in the number of mortgage applications from the previous week. That number includes "seasonal adjustments," without adjustments, morgage apps plunged 22.4% despite record low rates as government assistance begins to peter out. The Refinance Index, also adjusted for the holiday, decreased 16.8 percent from the previous week and the seasonally adjusted Purchase Index decreased 7.6 percent from one week earlier. The unadjusted Purchase Index decreased 16.7 percent compared with the previous week and was 3.4 percent lower than the same week one year ago.
Clearly the earnings reports that are coming in are still doing so mainly on cost cutting, not any underlying improvement in sales.
This week we had GCI with a beat but earnings are down 18%, some other notable revenue numbers are:
PETS +5%,
WFT -15%,
AAPL + 25%,
STLD - 54%,
TXN -15%,
WERN - 26%,
EAT - 21%,
CAT - 44%,
KO - 4%,
DRH - 15%,
DD - 18%,
GAP -5% (that’s food!),
ITW - 20%,
LXK - 15%,
EDU +26%,
OXPS - 7%,
BTU + 24%,
PCP - 27%,
SHW - 12%,
UAUA - 20%,
UNH + 8%,
WU - 5%,
CNI -16%,
CREE + 20%,
GILD + 31%,
ISRG + 19%,
NBR - 44%,
SNDK + 14%,
STX - 12%,
STM - 23%,
YHOO - 14%,
AAI - 11%,
APD - 21%,
ATI - 50%,
CAL - 20%,
MAN (jobs) - 26%,
SWK - 16%
So we get a general impression that sales are off about 15% from last year. Last year’s Q3 wasn’t that great you know, the market collapsed in September so we already knew things were falling apart last Q3 so these are not tough revenue comps we are facing. AFTER getting the revenue and profit numbers last October, the market went down considerably. Should we be concerned? Of course we should, any rational person would be but the markets are clearly IRRATIONAL right now so we are playing the market, not the data.

We have to willingly suspend our disbelief in order to play these markets and our play mix, though still cautious, is reflecting that forced change in attitude. Sure we still look at the data, but we do so while keeping in mind the great Bill Murray’s advice - "It just doesn’t matter!" As fundamentalists, of course we believe it will matter, A LOT, one day, but we’re well prepared for that turn. Meanwhile, let’s keep playing the cards we’re dealt.

So what if no one is buying houses - they don’t have jobs anyway so that’s just 13.7% less people who are likely to default on their mortgage. That must be good for banks right? Goldman Sach’s International Advisor, Brian Griffiths had the same advice as he spoke yesterday defending compensation in the finance industry as his company plans a near-record year for pay, saying the spending will help boost the economy. “We have to tolerate the inequality as a way to achieve greater prosperity and opportunity for all.” So don’t complain about GS taking record bonuses less than a year after we bailed them out for wrecking the US Economy, they are only making this money FOR YOU!

This is the same logic under which the entire market is celebrating our drastic reduction in the workforce. For more than a decade, we’ve been shifting millions of jobs overseas and it made companies more profitable but there had always been a fear of a backlash against outsourcing if the companies slashed workforces as well. Our little collapse last year took the stigma out of layoffs and suddenly they were in vogue - everyone is doing it and now the corporations have gotten rid of the "dead weight" of the American workers and now their plans are to focus more on the foreign consumers as these losers in America are all tapped out. This is just the same sort of slash and burn capitalism that US multi-nationals have practiced globally for decades only now it’s the US that’s being cut loose as the corporations move on to greener pastures."
Phil Davis and his group trade options all day and use a messaging system where they post all trades. You can try his service through a free trial here.

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