Falling Euro, Rising Oil Prices Are a
Bad Combination for Investors
Predictions of high earnings are
also likely to be way off
KATHLEEN PENDER
Wednesday, September 20,
2000
Ah, fall. Falling leaves. Falling rain. Falling
temperatures. And falling stock prices.
That's right. On average, September and October
are the worst months for stocks, according to Ned
Davis Research.
And this fall, investors have plenty to worry about.
First, there's the euro, which has fallen 10.5 percent
against the dollar since the end of June.
When the euro slides, American companies show
losses when they translate their European profits
into dollars. Many U.S. firms, even those that have
been hedging -- or trying to protect themselves
against a drop in the euro -- have warned that
they'll post third-quarter currency losses. More
companies are expected to follow suit when
``earnings confession'' season begins next week.
Then there are rising oil prices, which hurt
corporate profits three ways. They immediately
increase costs. They reduce revenues if consumers,
who make up two-thirds of the economy, cut back
on other spending.
And, if higher oil prices spark widespread
inflation, the Fed may raise interest rates, which
reduces profits even more.
Higher oil prices hit Europe especially hard, and if
European economies falter, the euro could continue
to tank, worsening currency losses for U.S.
companies.
Crude oil prices are up 43 percent this year and
are hovering near a 10-year peak. Gasoline prices
hit a record high in the Bay Area this month and
now top $2 per gallon in many cities.
Natural gas and heating oil futures have more than
doubled this year, and if there's a cold winter in the
Northeast, energy prices could surge.
Euro and energy fears have already taken a toll on
the market, and September is living up to its
reputation as a lousy month.
After surging in August, the Nasdaq composite
index is down 8 percent this month, and the S&P
500 is down 4 percent.
Some analysts think things could get even worse
during the next few weeks, when companies
preannounce and then finally report earnings for the
third quarter, which ends Sept. 30.
``The consensus (earnings) estimates for the S&P
500 are too high,'' says John Skeen, director of
portfolio strategy with Banc of America Securities.
He says the consensus calls for a 16 percent
year-over-year gain in third-quarter earnings,
followed by a 14 percent gain in the fourth quarter
and a 9 to 10 percent gain for the first quarter of
next year.
``I think it's quite likely that earnings will be more
like like 14 percent for the third quarter, 7 or 8
percent for the fourth and zero for the first,'' Skeen
says.
He says the market is predicting a ``perfect,
pillow-soft landing'' that is unlikely to pan out given
the slumping euro, rising oil prices, an increase in
unemployment claims and a slowdown in ``buying
intentions.''
Third-quarter worries actually started surfacing in
mid-July, when some big-name companies reported
mostly robust second-quarter earnings but warned
that third- quarter estimates were too high.
``We heard from Microsoft, Sprint, Lucent,
Ericsson, Nokia, Wal Mart. Investors had never
heard anything negative from these companies
before,'' says Anthony Crook, a research analyst
with First Call.
Joining the fray were a slew of consumer-cyclical
and retail companies such as Procter & Gamble,
Gap, Lands End, Saks, Whirlpool, Target, J.C.
Penny, Circuit City, Hertz, Target and Whirlpool.
More recently, Gillette, Alcoa, McDonald's, Eaton,
Dana, Ingersoll Rand, Sherwin Williams and
Maytag have all warned analyst to lower their
expectations.
Because these companies are so large, their
announcements got a lot of publicity. But earnings
trackers say that on the whole, the numbers don't
look so bad.
According to IBES, so far only 66.8 percent of
third-quarter earnings preannouncements have been
negative. That's below the average for the past four
years, when 81.4 percent of preannouncements
were on the downside.
Chuck Hill, research director with First Call,
predicts third-quarter earnings will be up ``a damn
good'' 19 percent over last year. But he also thinks
``you're going to see bigger problems in the fourth
quarter,'' when oil problems come home to roost.
On the positive side, capital spending remains
strong, as companies continue to scarf up any
equipment that will increase productivity. This is
good for the tech sector, and Hill sees no immediate
slowdown in tech earnings.
In fact, he thinks third-quarter tech earnings will be
up 36 percent this year, even better than last year's
31 percent increase over 1998.
However, ``if the U.S. economic slowdown gets
deep enough, it'll spill over into the techs.''
At the BofA Securities conference, which is taking
place at the Ritz-Carlton in San Francisco this
week, ``everyone is worried about capital
spending,'' says Skeen. ``What if it slows next year?
That's the big question that's being bandied about in
the hallways.''
The biggest threat to capital spending is a
recession, which could be triggered if oil prices
spill over into the rest of the economy.
Gary Schlossberg, an economist with Wells Capital
Management, doesn't see that happening, at least
not right away.
Adjusted for inflation, he says oil prices still aren't
as high as they were during previous spikes in 1974
and 1981.
The price of Saudi crude is $31.33 per barrel.
Adjusted for inflation, it would take a price of $43
per barrel to equal the price in January 1974 and
$69.75 equal the price in October 1981, he says.
``Oil in the past has triggered a recession,''
Schlossberg says. ``As oil prices rise, the Fed
tightens monetary policy'' to rein in inflation.
``This time, the rise in oil prices has been fairly well
contained. We're not getting the same kind of
spillover we've had in the past. So there's less risk
of a run-up in inflation and interest rates.''
Given that scenario, Schlossberg sees stock prices
rising, but not by much. ``Historically, the S&P has
returned to 10 to 11 percent a year,'' he says. Over
the next 12 months, ``chances are we'll see them in
the mid-single digits.''
Skeen predicts that, ``in 12 months, stocks will be
approximately 10 percent higher'' than they are
today, ``but they could have problems in the next
couple weeks as these earnings estimates get
ratcheted down.'' |
