Research & Insights

Posts published in July 2010

Earnings and Confidence

July 29, 2010

By Katrina Lamb, CFA

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Here is a perfect little encapsulation of the schizophrenic market environment we currently inhabit: with the earnings season in full swing 86% of S&P 500 companies reporting to date have beaten expectations, including a bevy of consumer heavyweights like Apple (as my colleague Masood Vojdani pointed out in his blog post earlier this week).  At the same time the Conference Board’s consumer confidence index declined for a second straight month to 50.4, its lowest showing since February.   Corporations are looking good, households are feeling glum.  No wonder the market has been on this lurching path to nowhere for the past several months.

It would seem rather intuitive that corporate profits and confidence go hand in hand, or at least have a reasonably robust coefficient of correlation.  It was Calvin Coolidge back in the 1920s who proclaimed that “what’s good for American business is good for America,” and that theme has become something akin to canonical law in this land since then.  The post-World War II boom that lasted through to the early 1970s saw a massive expansion of household income, industrial output, exports, dynamic consumer markets and every other meaningful indicator of economic progress.  The Great Growth Market of 1982-2000 likewise produced both record earnings for S&P 500 companies and increased household income (though also increased household debt, an ominous presage of things to come).

The relationship between confidence and earnings started to become less tenuous in the middle of the last decade.  Corporate earnings seasons during the latter half of the 2003-2007 growth market were a continual-motion case of “can you top this?”  Wall Street handily rewarded the record-busting earners, but meanwhile household incomes were flatlining, job creation was not keeping pace with natural population growth, and consumer confidence was tremulous – neither robust nor morose, but uncertain.  Of course, the confidence and earnings trajectories reunited in 2008 in the other direction as both plummeted with the Great Recession.

The current disparity of low confidence and high profits may be only temporary, of course.  But there is a plausible argument as to why that may not be the case, and here it is.  American households are, by definition, American.  They are made up of people who by and large live, work, raise children, shop, dine out, volunteer and pursue happiness in America.  The corporations that make up the S&P 500, on the other hand, are AINOs: Americans In Name Only.  Scour the income statements of the companies with the largest market caps and you will understand that these are truly citizens of the world.  Their fortunes are only partly tied to the country where their home offices are legally registered, and less so with each passing quarter.  When you travel overseas you see iPhone-toting teenagers in Moscow, GM-driving families pulling into KFC drive-in windows in Beijing, GE appliances adorning the bright modern kitchens of young urban couples in Kuala Lumpur.

But it is not just that our largest companies are selling to the world’s fastest-growing consumer markets.  They are also employing the citizens of these countries in droves.  Cisco recently invested over $1 billion to open a second headquarters in Bangalore, India.  This high-tech town in the Indian state of Karnataka is also home to GE’s largest R&D center anywhere in the world.  When you think of Indian citizens who work for US companies the image of the sari-clad woman in a small cubicle with headphone in ears, helping a caller from Cincinnati with questions about a mortgage payment, is woefully out of date.  At these gleaming corporate centers smartly-dressed members of the burgeoning middle class – a global force reckoned at around 6 billion strong – are pursuing their professional aspirations the way that upwardly-mobile Americans have for many generations.

And there is still one more piece of the puzzle.  In addition to consumer markets and production markets, the capital markets that fund US businesses are also relocating.  For the 12 months ended in June 2010 the percentage (by volume) of global initial public offerings (IPOs) that took place in the US was a mere 10%.  That means that the overwhelming flow of money into the “hot new things” that populate IPO markets flowed in other markets, facilitated by bankers, syndication experts and investors dispersed around the world.

What does this all mean?  The principal conclusion I draw is that the economy’s long-term recovery, such that it may be, could bear very little resemblance in its impact on American households to the two previous macro growth environments of the 1950s-70s and 1980s-00s.  Consumer, production and capital markets are global, increasingly frictionless and beginning to cluster in defined global regions like Southeast Asia.  The one means of production component that remains rooted to domestic turf is the actual supply of labor – the people who get up and go to work somewhere less than 60 miles from home (usually, though certainly not without exception!).  These people cannot simply pack up one night and reappear in Bangalore or Doha (Qatar) or Shanghai the next day.

So if the fortunes of American households and AINO corporations are indeed diverging, what does this mean for the economy, for the markets, for business-government relations, for the cohesiveness of our society?  These are questions to be taken seriously.  Expect to hear a great deal more from me and my colleagues in the weeks and months ahead.

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The Apple of Our Eyes

July 27, 2010

By Masood Vojdani

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The market has been going sideways for much of the past two months – sideways with extreme lurches up and down reflecting the persistent uncertainty among investors about where the global economy is headed.  Are Greece and Spain going to render the Eurozone a failed experiment in unifying distinct national economies?  Is China going to slam on the brakes and bring global growth to a screeching halt?  Are US consumers going to finally hang up their hats, retire their credit cards and call it a day?

I hear these questions in the predawn hours of every morning as the financial news accompanies my exercise routine.  A few weeks ago I was pondering it all as I was driving into work.  Now, my route to the Bethesda office happens to take me past the local Apple Store.  As I turned onto Bethesda Avenue I could see that this day was not like other days.   A huge crowd thronged outside the store and the line extended clear down to the end of the street.  Mind you, this was at 8am, two hours before the store was due to open.  Truth be told I was not surprised.  A fair number of Apple products can be counted among members of my household, and I knew what the big event was today – the launch of the iPhone 4.  The expectant masses on Bethesda Avenue that morning were there to part with upwards of $300 each for the latest “this will change the world” offering of Steve Jobs & Co.

The iPhone 4 had received decidedly mixed reviews by the techno-pundits in the run-up to the product’s launch.  Technical glitches, security issues – and I am assuming that a good number of the early adopters clamoring at the store entrance had read the reviews.  No matter – they all wanted another piece of the magic.  No doubt many of them had also shelled out for the iPad when that snazzy tablet appeared earlier in the year.

I usually am not one to conflate one data point into some larger explanation for What It All Means.  And Bethesda, one of the richest zip codes in the country, is hardly a proxy for the US at large.  But what happened that morning in suburban Maryland was happening all over the country as it turns out – iPhone 4s have been selling like hotcakes.  Not surprisingly, Apple’s formidable earnings announcements last week were a meaningful reference point for the strongest week in stock market performance for some time now.  Here’s how I see it: American consumers seem perfectly willing – giddily so – to part with hundreds of dollars for technology that – let’s face it – is as much about hype and glitz as it is about real functionality.  This does not say “economy in freefall” to me.

Our consumer economy has been vibrant for decades, surviving the nastiest of downturns along the way, because our wants keep evolving into needs over and over again.  Does anyone really need an iPhone 4 or an iPad?  Not in the strict sense of the word – but if the perception of need exists then the need is real.  We see this play out every time we switch on the AMC drama Mad Men, now in its 4th season.  One of the really enjoyable things about that show is seeing the postwar consumer culture take root and permeate throughout all economic and cultural strata of the society, with “Relaxicisers” and Kodak Carousels filling the emergent needs of that time the way that iPhones and Viking grills do today.

There is a great deal of doomsday commentary out there.  While I certainly do not intend to underestimate the scope or depth of our current economic woes, and particularly for the many who are out of work or underemployed, I also am fairly confident that our consumer culture is not grinding to a halt.  For better or worse it is a deeply ingrained aspect of our economy and our society, and I expect to see those same breathless crowds amassing outside the Bethesda Avenue store next time Steve Jobs proclaims that the future has arrived in the form of some stylish construction of bits and bytes.

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The Week Ahead: The Market's Dog Days

July 12, 2010

By Katrina Lamb, CFA

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The dog days of summer are upon us. We all have different ways of marking our seasonal calendars: my own “dog days” typically kick in after the July 4th holiday and the Wimbledon tennis finals, knowing that the next combination of a long weekend and Grand Slam tennis tournament will come in early September with Labor Day, the US Open and the new energy that anticipates autumn. Between now and then it’s all about the heat and humidity that define summers along the languid byways of the Chesapeake Watershed Region.

Investment markets seem to be feeling the heat as well – heading upwards for several days and then listlessly falling back like a Metro passenger dealing with a broken escalator in the midday sun. Even the renowned 3:30 Club has been somewhat muted of late – while we have had our fair share of 1%-plus days, we’ve seen fewer of those extreme lurches at the end of the trading day when the computer algorithms kick in with their hairtrigger buys and sells. Maybe the algorithms, too, are kicking back at Bethany Beach or casting their flies in the Savage River…

The major variable heading into the next couple weeks is the onset of corporate earnings season, kicking off as usual with Alcoa’s announcement after today’s market close. Investors will be interested to get more data points to help them sort out all the conflicting signals in the economy. Earnings surprises on the upside will add more weight to the default hypothesis that we are not headed towards the precipice of an imminent double-dip recession, and the consensus sentiment seems to anticipate this being the case. Of course, “surprises” in the earnings world are a double-edged sword, and early signs of stress by redoubtable market heavyweights like GE or Intel could set a negative tone for the season.

Over the course of this year to date we have characterized the global economic recovery as a series of “fits and starts”. Earlier in the second quarter there seemed to be more starts than fits and the US appeared to be gaining traction in shoring up global growth. The intensifying problems in second-tier European nations back in May raised the specter of more “fits” given the implications of solvency problems in the Eurozone for the US as well as the global growth engines of China, Brazil and India. Observers of macroeconomic policy are stuck between the rock of unsustainable deficits and the hard place of unbudging unemployment, underemployment and falling incomes. And thus the listlessness and indecision that bedevil the markets as moist droplets of hot air shimmer above the Potomac River.

Robust earnings could indeed stir the market out of its torpor and provide some direction, but we think there is an equally plausible case to make that the fits and starts may continue to contain any bull or bear tendencies from breaking out too decisively in either direction. Maybe it’s just the effect the dog days have on us, but we see the opportunity for sluggishness to continue being the market’s defining characteristic.

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