Puplava:
>>What is the reason behind this latest series of one-two-three-day miracles? It is intervention followed by spin. Stories out today are that companies are reporting earnings so far for this quarter at about 2.4% above estimates. Let’s first establish the fact that we are still talking about CRAP numbers and not GAAP. The second point to understand is that Wall Street started out the year by projecting pro forma profit growth for the third quarter of over 30% and 40% growth for the fourth quarter. After the disaster in earnings in the second quarter, pro forma estimates for Q3 were revised down to 17%. As recently as last week these numbers were still being adjusted downward to slightly over 5%. Fourth quarter estimates are still too high and will have to be adjusted downward much further, especially after what companies have been saying about Q4 and next year. That will happen next year, as we get closer to the Q4 reporting season in January. It is all part of the earnings game that is played and spun each quarter with the same results. Companies report lower earnings, lose money, and report worsening fundamentals. Wall Street and the media then spin the results to look better, hoping the public doesn’t catch on.<<
Thursday, October 17, 2002
SPIN CYCLE
How do you make a bad situation look better? The remedy is called spin. Actual events are recast and retold and appear to the general public in a different light. The sudden rise in stock prices that began last week at key support levels was the result of heavy buying by Goldman Sachs and Merrill Lynch. The initial upsurge was attributed to a technical bounce from an oversold market condition. In reality it looked more like intervention. I’ve already written about this in last Friday’s WrapUp and on Monday. I call it the “rope a dope,” where market intervention is used to lure unsuspecting investors back into the market. John Crudele, writing in the New York Post, attributed the markets machinations to televised wrestling. “What’s the difference between professional wrestling and the stock market? Everyone knows wrestling is fixed. With Wall Street you only suspect it.”
The trademark of the “rope a dope” rallies are morning rocket launches or late afternoon miracles where a plunging stock market miraculously recovers and rises several hundred points. Usually some glib or inane reason is given for the miraculous turn around. Today’s turn around was attributed to IBM beating analysts’ estimates by $0.03 cents a share. The actual story was much different. IBM’s net income actually fell to $1.31 billion from $1.6 billion the year before. Revenue was essentially flat from last year falling slightly from $20.4 billion to $20.3 billion. The latest quarterly results included a loss from discontinued operations of $381 million from its money-losing hard disk division. The company plans on selling the unit to Hitachi Ltd. by the end of the year. The losses from this division were nearly triple the year before. Income from continuing operations actually dropped slightly by 1% during the quarter. In a conference call with investors, IBM’s chief financial officer said with customers prolonging buy decisions, he wasn’t able to make any predictions on the company’s business outlook for 2003. IBM has achieved its lower numbers by cost cutting on R&D and trimming its payroll. The company reduced its payroll by 15,000 in the second quarter. IBM also warned that pension income, which has been a big contributor to earnings, would hurt results in coming quarters. IBM will need to contribute $1.5 billion to keep its pension plan fully funded by 2005. A number of IBM’s competitors such as EDS and EMC have warned that Q3 results were going to be weak and that Q4 and next year don’t look any better.
The spin behind the miraculous bounce this morning was that IBM’s good fortune negated the bad news coming from Intel. Actually, IBM’s news confirmed the bad news coming from Intel. It was just spun differently. Wall Street and cable anchors went with the “beating estimates” story. The miraculous rise of several hundred points in the market was attributed to the fact that business conditions are improving and that things are getting better in the economy. Nothing could be further from the truth.
The only real difference is spin. Is the market rising because earnings have improved? No. Actual earnings are still in a downtrend. Is it because the economy has improved? No. This morning the Philadelphia Fed reported that its regional manufacturing index was minus 13.1 this month, the lowest number since November of last year. Has it been a change in Washington? No. The Senate under Daschle has held up everything from plans to increase energy, to judicial appointments, and plans for economic stimulus, including tax cuts. The only thing that has been proposed is a new $200 billion welfare program, hardly a catalyst for long-term economic growth. The Senate has kept economic issues in gridlock so it has been politics as usual. There is nothing that has come out of Congress to improve the economic landscape. The only good news is that they haven’t passed any more harmful legislation.
What is the reason behind this latest series of one-two-three-day miracles? It is intervention followed by spin. Stories out today are that companies are reporting earnings so far for this quarter at about 2.4% above estimates. Let’s first establish the fact that we are still talking about CRAP numbers and not GAAP. The second point to understand is that Wall Street started out the year by projecting pro forma profit growth for the third quarter of over 30% and 40% growth for the fourth quarter. After the disaster in earnings in the second quarter, pro forma estimates for Q3 were revised down to 17%. As recently as last week these numbers were still being adjusted downward to slightly over 5%. Fourth quarter estimates are still too high and will have to be adjusted downward much further, especially after what companies have been saying about Q4 and next year. That will happen next year, as we get closer to the Q4 reporting season in January. It is all part of the earnings game that is played and spun each quarter with the same results. Companies report lower earnings, lose money, and report worsening fundamentals. Wall Street and the media then spin the results to look better, hoping the public doesn’t catch on.
How do you make a bad situation look better? You control the spin by recasting the bad situation a more favorable light. If the numbers don’t come in as anticipated, you keep lowering the benchmark on a revolving basis until the results actually look good. You will notice the story is over how much a company met or beat analysts’ estimates. This keeps investor attention focused away from actual results. The dearth in earnings improvement is never talked about or analyzed. The story is always on the estimates, which are always made to make earnings look better than they actually are. It is all part of a rigged game that is looking more and more like professional wrestling. The truth of the matter is what actually goes on Wall Street these days is beginning to resemble an adult fantasy theme park. What you see is more fantasy and fiction. Nonfiction went out in the 90’s with the new era in earnings and reporting. The government is now busy investigating much of the fiction of that era while ignoring the fiction of today.
The Four-Step Rally Process
Phase 1 One-two-three-day rallies, sparked by intervention at key support levels.
Phase 2 Short covering drives violent upside surge in indexes.
Phase 3 Day traders come in and increase short-term momentum.
Phase 4 John Q comes in at end of rally after uptrend has run out.
Please review today’s graph of the Dow, which is indicative of the “rope a dope” rally syndrome. The market rallies over this last week have taken on this similar pattern. The morning opens up with the markets shooting straight up like a NASA space launch and then remains at those levels for the rest of the day. The action begins in the futures pits and carries over into the markets. The pattern is straight up and then right angled the rest of the day. Insiders know this is contrived. It remains a question if the public will gets suckered in on another investment mirage or con job.
The real story has been buried in all of the background noise of today’s over-saturated financial coverage. Actual corporate profits peaked more than five years ago in 1997. They have been going downhill ever since. Profits in the non-financial sector peaked at $504.5 billion in 1997 and have now fallen to $291.1 billion as shown in this table taken from a recent Richebacher Report. More importantly is the fact that with each new economic revision these numbers are revised even lower. This is a story you never hear mentioned on Wall Street.
U.S. Downward Revisions of Profits of Non-Financial Sector (in $ Billion)
1997 1998 1999 2000 2001 2002
Original Numbers 504.5 506.8 530.4 577.9 371.4 291.1
Benchmark Revision 2000 504.5 478.8 467.8 491.8 371.4
Benchmark Revision 2001 504.5 478.8 455.9 423.0 333.7
The other story we have harped on is that the only thing keeping us out of a more serious recession is a willing consumer who is able to take on more debt in order to support consumption. Debt is the only thing driving our economy, government debt, state and municipal debt, corporate debt, and consumer debt. In Washington, Wall Street, and in universities they all think this is healthy.
In the end the truth always wins out and the markets have their way. That’s why stocks have fallen for three years now. The decline in the market is more a true reflection of the underlying economic and profit trends, which are worsening.
Looking at today’s spin cycle, stocks rose due to higher than expected earnings from IBM, Kodak, and United Technologies. Two-thirds of the companies reporting so far have beat estimates, hardly a distinction. Kodak beat estimates as a result of a tax benefit. The company reported 41.15 a share in profits. Without additional items the company said it would earn $0.70-$0.80 cents a share. Kodak sold more film but revenues were about the same due to lower prices. Part of the company’s revenue gains came from foreign currency gains. Without those gains, third-quarter revenue would have fallen 1%. Kodak has had to cut prices the last three months in response to competition from Fuji Photo Film. The firm’s consumer sales fell 3%. Kodak is locked into a price war reducing prices and chasing shrinking volume in its core business.
United Technology reported higher sales and earnings, thanks to increased sales and margins at its Carrier air conditioner and Otis elevator units. United Technology has offset weakness in its aerospace division by trimming payroll and strong sales from its residential air conditioner unit. Air conditioner sales have been particularly strong due to the housing bubble.
Economic News
In other news, helping the markets was news that home construction in September rose to the highest level in 16 years. The strong housing bubble is helping to offset a worsening picture in manufacturing. Housing starts also rose by 13.3% last month indicating that the housing bubble is still in the process of inflating.
The manufacturing sector continues to slide with industrial production falling 0.1% last month. Industrial capacity fell to 76% in August, indicating that one of four factories are now idle. This explains why most companies are reluctant to spend on capital investment. No reason to buy new machinery and equipment if you aren’t using the equipment you already own. It is also another reason why companies are still trimming back payrolls aggressively. Last week state unemployment claims jumped from 389,000 to 411,000. Buried in today’s news were more layoffs coming from Sun Microsystems. The company will cut 4,400 jobs, or 11% of its workforce. The company lost $11 million during the last quarter and sales fell from $2.9 billion to $2.7 billion. Demand for the company’s servers have fallen dramatically as most companies postpone capital investments. This is forcing the them to trim back its workforce.
Delta Air announced it would cut as many as 8,000 jobs as losses mount. There were also more earnings disappointments that got overshadowed by the news coming from IBM and Kodak. Sears shares tumbled 32% after the company set aside $222 million to cover unpaid credit card bills. Sears is increasing reserves to cover uncollectable credit card bankruptcies. Net income dropped 28% to $189 million while revenues declined for the second consecutive quarter. Ebay’s third quarter revenues rose 49%, but the company stock is selling at 80 times recent earnings. Investors seem to want to hold out until the price of the stock gets less expensive. Shares of Ebay rose $.17 to $57.15.
In late news, Microsoft reported higher sales and revenues, and S&P cut the credit ratings of Merrill Lynch, Morgan Stanley and Goldman Sachs. The credit rating agency cited a decline in profitability of securities brokers. Lower credit ratings will raise the cost of capital for these firms.
In the bond market things aren’t going as well as the bond market continues to get hammered. Long-dated 10-year notes fell 1 5/32nds with the yield now back firmly over 4%. This will raise the cost of most mortgages. The 3-year bond lost even more falling 1 17/32 to yield 5.11%. Rising long-term interest rates could spell trouble for the mortgage refi market and housing if they continue to rise as they are doing currently. On Wednesday the long bond rose above the key benchmark rate of 5%.
Volume was heavy today with 1.76 billion shares traded on the NYSE and 1.81 billion on the Nasdaq. Winners outnumbered losers by a 22 to 10 margin on the big board and by 24 to 9 on the Nasdaq. The VIX dropped 1.81 to 40.16 and the VXN fell .65 to 56.22. A rapid drop of both sentiment indicators could indicate an approaching end to this artificially induced rally.
Overseas Markets
European stocks gained as SAP AG, Nokia Oyj, Prudential Plc and Wella AG reported sales or profit that beat analysts' estimates, and DaimlerChrysler AG increased its revenue forecast. The Dow Jones Stoxx 50 Index added 3.5% to 2624.95, taking the index to its highest in more than a month. All eight major European markets were up during today's trading.
Japan's Nikkei 225 Stock Average advanced, led by Sony Corp. and other computer-related companies, after International Business Machines Corp. said fourth quarter sales will rise. Japan's Nikkei added 0.3% to 8913.32.
financialsense.com |
