Please note: There will be no market commentary next week due to the Easter holiday. Thank you and have a nice holiday.
Lackluster earnings created a pessimistic mood for the markets this week. At the close on Friday, the Dow was off 0.3% while the S&P and Nasdaq were both lower by 0.6%. Most commodities were higher, with gold reaching another all-time high, up 0.8%. Oil was lower, but closed at a still troublingly high $110 per barrel (Brent crude closed over $123 per barrel).
Source: MSN Moneycentral
Corporate earnings were the big story of the week. First quarter earnings releases began this week and they tend to set the tone for the next several weeks. Most economists and investors predict that the solid earnings of the last several quarters will continue this quarter, so expectations are high.
The aluminum producer, Alcoa, kicked things off Monday evening with their first quarter results. The earnings were satisfactory, but their revenues were not (Revenue is what the company actually earned by doing their business. Expenses are deducted from the revenues to get net income, or earnings). Higher commodity and energy prices were cited as a major hindrance to their performance. This set the tone for Tuesday and the market dropped.
As the week progressed, we received earnings from many other companies. It seemed like there was a little bit of good news, but also a little bit of bad news in each one.
Two important banking stocks, JP Morgan and Bank of America released their earnings. They were decent at JP Morgan, but not for BAC. Revenues for both companies were poor, though. Looking at their numbers, a theme has appeared that we may see in other banking companies. They severely understate the losses from bad assets like mortgages and loans in order to look better.
Without getting too technical, banks are able to use mark-to-model accounting to value these products. So whatever their model tells them the bad loan is worth, they can use that number. But that model can tell them anything they want it to tell them.
The alternative is mark-to-market, which requires banks to value the product at whatever price they can get in the market at that time. If a bad mortgage is worthless, they have to count it as worthless. Now, though, if their model tells them a loan is worth 70 cents on the dollar, guess which number they will use? This is the main reason we are avoiding the banking sector. Companies that play games with accounting are more trouble than they are worth.
Getting back on subject, Google was another company to release their earnings and looked like they did well. Their costs increased significantly, though, mainly due to higher operating expenses like labor prices. Google shares got pounded as a result.
Other notables were toy manufacturers Hasbro and Mattel. Both had poor earnings that were attributed to higher input costs. This is a story that we worry will be found in other earnings reports.
The poor showing this week has already caused many economists to lower their growth forecasts for the first quarter. Previously, we heard most economists predicting anywhere from 3 ½ to 4% GDP growth for the quarter. There have been some significant downward revisions, most of which are now under 3% and even some under 2%. While this is a possibility, we think it is too early to draw any conclusions from the limited data.
Lastly, both the producer price index (PPI) and consumer price index (CPI) were released this week. Not surprising, they came in remarkably low, indicating there is little to no inflation. It is almost laughable how absurdly unrealistic these figures are. As we have mentioned in the past, we feel these figures don’t accurately represent inflation in the economy.
However, it is important to remember that these are some of the figures the Federal Reserve looks at to determine fiscal policy. If inflation is high, they will reign in some of their stimulative policies. Since the figures they look at show this is not the case, we don’t see any reason why they will tighten monetary policy any time soon. That means higher commodity prices and a weaker dollar will be with us for some time.
Next Week
Next week is a short week for the market, as it will be closed Friday for the Easter holiday. Economic data will be light, with just some information on housing and leading economic indicators.
Corporate earnings will be very busy, though. Over the next two weeks, 70% of S&P 500 stocks will have released their earnings. There will be plenty of information to move the market, as well as to give us a better idea on the strength of the economy, so it should be plenty busy.
Investment Strategy
Little change here. The bar has been set high for these first quarter earnings. We worry, though, that these earnings will be disappointing, as we are beginning to see. With high and rising commodity prices, businesses are getting hit with higher costs that they have not yet passed along to their customers. This will negatively impact their earnings and would normally send their share price lower. Perhaps it won’t occur this quarter, but we do believe it will happen in the coming months, so we remain cautious.
We have other concerns over the economy, as well. Gas prices are very troubling, with the average now at $3.81 a gallon. The all time high is $4.11, so we are not that far away. Despite what the Fed says, inflation is strong. Additionally, unemployment is high and housing data worsening. We strongly believe a stagflation scenario is brewing.
Even with this negative outlook, we still think the market will head higher. We believe that Fed Chief Ben Bernanke will keep flooding the market with money to push the market higher, as has been the case in recent months. The QE2 bond buying stimulus program is set to expire this summer and without the Fed intervention, the market will likely fall. We feel that the Fed has too much invested for that to happen, so they will likely double down and try another quantitative easing program if that does happen. This will keep the markets higher in the short term, but will cause serious problems down the road.
At this time, in equities we are focused on large cap higher-quality and multi-national stocks. Large cap has lagged mid and small, so there could be more room to run in this area. We continue to avoid banking and healthcare-related stocks. TIPs are important as we expect inflation to increase in the future, while U.S. Treasuries are a sector we are very bearish (pessimistic) on as we think yields will increase over time.
Commodities remain a long term favorite and any weakness could present buying opportunities since they are rather expensive at the moment. Municipal bonds are still important despite the recent drop in prices. There are some nice yielding bonds out there now (try to avoid muni funds and buy the actual bond if possible). Finally, international stocks have had a significant run already and are facing many headwinds for the future, especially inflation. Still, if we had to put new money in, we are favoring developed international markets as opposed to emerging.
Our short and medium term investments are the only ones affected by these weekly and monthly changes. These fluctuations have little impact on positions we intend to hold for several years or longer.
Lackluster earnings created a pessimistic mood for the markets this week. At the close on Friday, the Dow was off 0.3% while the S&P and Nasdaq were both lower by 0.6%. Most commodities were higher, with gold reaching another all-time high, up 0.8%. Oil was lower, but closed at a still troublingly high $110 per barrel (Brent crude closed over $123 per barrel).
Source: MSN MoneycentralCorporate earnings were the big story of the week. First quarter earnings releases began this week and they tend to set the tone for the next several weeks. Most economists and investors predict that the solid earnings of the last several quarters will continue this quarter, so expectations are high.
The aluminum producer, Alcoa, kicked things off Monday evening with their first quarter results. The earnings were satisfactory, but their revenues were not (Revenue is what the company actually earned by doing their business. Expenses are deducted from the revenues to get net income, or earnings). Higher commodity and energy prices were cited as a major hindrance to their performance. This set the tone for Tuesday and the market dropped.
As the week progressed, we received earnings from many other companies. It seemed like there was a little bit of good news, but also a little bit of bad news in each one.
Two important banking stocks, JP Morgan and Bank of America released their earnings. They were decent at JP Morgan, but not for BAC. Revenues for both companies were poor, though. Looking at their numbers, a theme has appeared that we may see in other banking companies. They severely understate the losses from bad assets like mortgages and loans in order to look better.
Without getting too technical, banks are able to use mark-to-model accounting to value these products. So whatever their model tells them the bad loan is worth, they can use that number. But that model can tell them anything they want it to tell them.
The alternative is mark-to-market, which requires banks to value the product at whatever price they can get in the market at that time. If a bad mortgage is worthless, they have to count it as worthless. Now, though, if their model tells them a loan is worth 70 cents on the dollar, guess which number they will use? This is the main reason we are avoiding the banking sector. Companies that play games with accounting are more trouble than they are worth.
Getting back on subject, Google was another company to release their earnings and looked like they did well. Their costs increased significantly, though, mainly due to higher operating expenses like labor prices. Google shares got pounded as a result.
Other notables were toy manufacturers Hasbro and Mattel. Both had poor earnings that were attributed to higher input costs. This is a story that we worry will be found in other earnings reports.
The poor showing this week has already caused many economists to lower their growth forecasts for the first quarter. Previously, we heard most economists predicting anywhere from 3 ½ to 4% GDP growth for the quarter. There have been some significant downward revisions, most of which are now under 3% and even some under 2%. While this is a possibility, we think it is too early to draw any conclusions from the limited data.
Lastly, both the producer price index (PPI) and consumer price index (CPI) were released this week. Not surprising, they came in remarkably low, indicating there is little to no inflation. It is almost laughable how absurdly unrealistic these figures are. As we have mentioned in the past, we feel these figures don’t accurately represent inflation in the economy.
However, it is important to remember that these are some of the figures the Federal Reserve looks at to determine fiscal policy. If inflation is high, they will reign in some of their stimulative policies. Since the figures they look at show this is not the case, we don’t see any reason why they will tighten monetary policy any time soon. That means higher commodity prices and a weaker dollar will be with us for some time.
Next Week
Next week is a short week for the market, as it will be closed Friday for the Easter holiday. Economic data will be light, with just some information on housing and leading economic indicators.
Corporate earnings will be very busy, though. Over the next two weeks, 70% of S&P 500 stocks will have released their earnings. There will be plenty of information to move the market, as well as to give us a better idea on the strength of the economy, so it should be plenty busy.
Investment Strategy
Little change here. The bar has been set high for these first quarter earnings. We worry, though, that these earnings will be disappointing, as we are beginning to see. With high and rising commodity prices, businesses are getting hit with higher costs that they have not yet passed along to their customers. This will negatively impact their earnings and would normally send their share price lower. Perhaps it won’t occur this quarter, but we do believe it will happen in the coming months, so we remain cautious.
We have other concerns over the economy, as well. Gas prices are very troubling, with the average now at $3.81 a gallon. The all time high is $4.11, so we are not that far away. Despite what the Fed says, inflation is strong. Additionally, unemployment is high and housing data worsening. We strongly believe a stagflation scenario is brewing.
Even with this negative outlook, we still think the market will head higher. We believe that Fed Chief Ben Bernanke will keep flooding the market with money to push the market higher, as has been the case in recent months. The QE2 bond buying stimulus program is set to expire this summer and without the Fed intervention, the market will likely fall. We feel that the Fed has too much invested for that to happen, so they will likely double down and try another quantitative easing program if that does happen. This will keep the markets higher in the short term, but will cause serious problems down the road.
At this time, in equities we are focused on large cap higher-quality and multi-national stocks. Large cap has lagged mid and small, so there could be more room to run in this area. We continue to avoid banking and healthcare-related stocks. TIPs are important as we expect inflation to increase in the future, while U.S. Treasuries are a sector we are very bearish (pessimistic) on as we think yields will increase over time.
Commodities remain a long term favorite and any weakness could present buying opportunities since they are rather expensive at the moment. Municipal bonds are still important despite the recent drop in prices. There are some nice yielding bonds out there now (try to avoid muni funds and buy the actual bond if possible). Finally, international stocks have had a significant run already and are facing many headwinds for the future, especially inflation. Still, if we had to put new money in, we are favoring developed international markets as opposed to emerging.
Our short and medium term investments are the only ones affected by these weekly and monthly changes. These fluctuations have little impact on positions we intend to hold for several years or longer.
