Earnings season has begun in the United States and so far there is a very familiar tone. Things at the corporate level in the country continue to gradually improve. There is continued evidence that business isn’t bad, but confidence levels are quite low. A phrase I hear more and more nowadays is “cash rich, confidence poor”. According to Bloomberg this morning, 78 of the 110 companies in the S&P Index that have reported earnings results so far have exceeded expectations. A number of others were in-line with estimates; and those that have failed to meet expectations haven’t missed by a very wide margin on average. In short, earnings season is off to a reasonable start. While we can’t yet know how it’ll finish, based on the comments of the companies that have reported to date, it seems realistic to think the overall results when all companies have reported will show the majority cleared a fairly low bar.
The concerns center on this critical issue of such low confidence. There is very low confidence at the moment in both the consumer and corporate sectors, but for the moment I want to just focus on corporate comments. Time and again we’re hearing from companies that they have subdued expectations for upcoming quarters due to the ongoing uncertainty of the business environment in the future. We hear that the economy and business demand isn’t primarily what makes them cautious. Instead it is the questions that surround the cost of doing business and corporate taxation that has them wondering if they can continue their current modest rates of growth and hiring patterns. Nobody is popping champagne bottles because business is booming, but the tone that business is clearly healthier than anticipated on the bottom line is very consistent through most segments of the economy according to these current sets of earnings reports.
The result is that corporations show respectable earnings, but then tend to hoard these earnings due to uncertainty. Rather than being confident enough to put these earnings immediately to work in expansion, hiring, dividend hikes, acquisitions, etc., the money sits idle. In total, this amounts to trillions of dollars sitting around earning next to nothing having a net negative impact on corporations, their shareholders, and the economy on the whole – largely because confidence is so poor.
While a majority of this low confidence level is owed to the uncertain outlook about economic policy and business regulation, it isn’t fair to say this is the only culprit. There are still the justifiable concerns about the economic conditions of Europe and China. Here again we have seen corporations say things aren’t as bad as had been expected from a business perspective; commenting that things are weak, but not altogether dead; but yet again the tone is subdued.
We’re continuing on a long path of slow healing on a global scale. Here at home Fed Chairman Bernanke gave recent testimony stating that he expects progress on unemployment to be “frustratingly slow” and that he expects the economy here to “pick up very gradually”. I agree with him. He also testified that housing is seeing “modest signs of improvement”, and I agree with him on this issue as well. I have clients across the country and in a number of foreign countries as well. I hear a similar story that each of their local housing markets has grinded around these lower prices in recent months and that things anecdotally seem to be showing signs of life again. Housing is a very large piece of the recovery story. If we see even modest proof of a pick up there, it will go a long way throughout the food chain of the overall economy. It’s early, but recent data is finally encouraging.
So as earnings likely continue to clear relatively low hurdles, the more important thing than the earnings themselves will be the commentary about future expectations. Expect to hear a very common story about how CEOs have positioned their corporate balance sheets very conservatively as they wait for guidance on the business environment. We’re in a time where those that should be in control of their own destinies are held captive by the unknown. The good news is that once answers to the questions finally come, good things tend to happen even if the answer wasn’t the one the market might have preferred. This underscores that bad news, per se, is better than no news. Perhaps not immediately, of course; but in time businesses can adjust and have historically proven to grow earnings even after being hit with what might initially be perceived as a deadly blow.
Please keep in mind that whenever I comment on ‘policy’, I’m not necessarily taking a political party stance. I believe good (and bad) policy can come from either side of the aisle and that we need to see genuine bipartisan solutions to some of the largest ills that plague our historically wonderful and effective system. Nobody has a monopoly on good ideas, but I’m afraid neither party has put forth anything just yet to improve overall confidence at either the individual or corporate level. I believe that the sooner we have clarity on key economic and business policy issues, the better. These things are almost surely not going to come prior to the election, so we need to be patient.
In this period, we continue to see that business is rolling on, albeit more slowly than we’d like. I still think investors should maintain a balanced approach. It would be a poor choice to give up on growth, but also a poor choice to take false comfort in things and align a portfolio with the notion that growth oriented assets are all you need. It is possible the markets have stolen a bit of their future upward potential as they price-in the idea that Europe will skirt disaster and things like the fiscal cliff debate will be resolved with little difficulty. I wish I could be so sure of those things, but I can’t. I don’t think there is great danger on the horizon, but I also don’t think we’ve gotten to the point where my longer term bullishness should be overemphasized. If we see a correction in the markets in the second half of the year, it will likely be a buying opportunity more than a beginning of a new trend lower. With corporations so rich with cash and with expectations already so low, a prolonged dip in markets is less likely. With a balanced portfolio that includes many high yielding assets, investors should take a bit of comfort in those very high corporate cash balances.
The takeaways:
- You’ve heard me say this before, I’m sure, and I know you’ll hear me say it again – always remember that sensationalism sells, but it is rarely profitable. In other words, sensationalistic commentary will always get air time and sell books, but acting on those sensationalistic comments isn’t likely to lead to an increase in your hard earned capital. So be careful as the summer rolls on. During this period, Europe’s mess will garner even more headlines, and the campaign process of the election will fuel many fires for the extremes from either party. The facts that will be presented will likely be distorted and the debate about potential outcomes will lead you to believe the end of the world is right around the corner. Don’t let the tone of the headlines wear you down – and listen with caution.
- Earning season will show the opportunities that exist in the markets since corporations continue to grow their earnings even in slow economic times. But the commentary from CEOs about a cautious outlook shouldn’t be ignored either.
- A balanced approach to an investment portfolio continues to be best, in my opinion. Both fear and greed are currently misplaced.
Commentary by Financial Advisor Jeff Winn – Orlando FL
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