Market Talk

Today’s Upshot column, about rising costs and margin pressures for corporate America, comes with some pretty good timing. Today’s Wall Street Journal has a page-one story about rising prices, right up at the top, four columns. Pricing pressure for a range of commodities is shaping up as one of the themes at Davos (not that anybody there’s going to do anything about it, they’re all too busy trying to get Bono’s autograph (think we’re bitter about not getting press credentials? Think we’re bitter about freezing in New York when we could be freezing in Switzerland with Bono? Of course not.))

The paper interviewed ECB chieftain Jean-Claude Trichet, who warned about rising inflation, and said, without saying it of course, that the central bank will move to contain it, which means raising interest rates. The euro has responded in kind.

Margins are already a big theme amid fourth-quarter earnings reports, and we think it will remain a big theme this year. Companies across a range of industries are talking about it. They always do, but what’s different about the talk this quarter is that companies are finally saying they’re going to be forced to raise prices, no matter the state of the consumer.

From our column:

There are signs that margins may be hitting a plateau. After bottoming out in 2008, operating margins for S&P 500-Stock Index companies have improved steadily, and are near pre-recession levels again. For the fourth quarter of 2010, operating margins for the S&P 500 companies are expected to be 8.8%, according to S&P, down slightly from the third quarter’s level of 8.95%.

Operating margins are expected to average about 9.08% in 2011, according to S&P. But if consumer demand doesn’t drive up sales enough to offset the rising costs, and at this point in the recovery that still appears likely, margins will be capped, and so will profit growth. So companies will be forced to raise prices, cut costs, or both.

Adding surcharges to product prices is one move industrial manufacturer Parker Hannifin Corp. is considering, Chief Executive Donald Washkewicz said. “Because we’re not going to absorb these increases,” he said last week, citing higher raw materials prices. “We can’t absorb them, and we’re just going to have to pass them on.”

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One thing that’s been a big boost to the banks is the accounting of reserves the banks set aside to cover losses. During the recession, the banks set aside billions, tens of billions, to cover losses. Now, with the economy leveling out, the banks are starting to release those reserves, which get counted now on the bottom line as a boost to earnings.

That’s the subject of today’s Upshot column in the Wall Street Journal:

Earnings at U.S. banks continue to benefit from cheap borrowing rates, and stronger consumer balance sheets.

Comerica Inc., Citigroup Inc., and J.P. Morgan Chase & Co. have posted fourth-quarter profits up strongly versus a year ago as loan-loss provisions subside—and in some cases are released to earnings.

The results offer new support for the economic recovery. In part, profits improved due to declining default rates. Defaults on consumer mortgages, auto loans and bank cards declined in November and December from a year ago. On Wednesday, fresh reports from Bank of New York Mellon Corp., U.S. Bancorp and Wells Fargo & Co. should further back the trends.

Still, credit costs remain a wildcard this year. Unemployment is expected to remain high, the U.S. housing market has been slipping in recent months, and the specter of a fresh wave of foreclosures remains.

You can make the argument the reserves should be ignored if you want to get a true picture of a bank’s underlying fundamentals.

You can also make an argument that, if the economy falters (and despite all the bubbly optimism on Wall Street and in the White House, that’s still a distinct possibility) the banks are going to regret letting all that money out the door.

These earnings seasons really creep up on you; I feel like I’m barely over the last one, and now here comes corporate America with their fourth-quarter reports. The fourth quarter’s always heavy on the commentary; companies are reporting the quarter, the year-end, and looking ahead to the next year. It’s a lot to get through.

Here’s your basic take-away: fourth-quarter results will be good, probably hitting the proverbial “better than expected,” (given the way the expectations game is played on Wall Street, they’re almost always better than expected), but whether or not the execs say it, profit growth in 2011 is set to slow down sharply from 2010.

Part of this is because 2010 had 2009 to compare itself to, a not particularly great year. This year will be comparing itself to the much-improved 2010. The other problem is the U.S. economy and the state of the consumer. Despite all the over-heated hoopla over the holiday season, the vast majority of Americans remain mired in a slump, and that’s putting it politely. That reality will keep a lid on just how much the U.S. economy can grow, and that will be a weight on corporate earnings.

All that’s by way of setting up our earnings primer in today’s Journal:

Companies start reporting final 2010 earnings in earnest this week, but the gains should peak this quarter then level off as high unemployment and new headwinds restrain further business profit gains.

Pressures from rising costs and tougher comparisons are draining the momentum from corporate profits. While some businesses should see a modest boost this year from new tax-law depreciation changes, big profit gains are largely behind many industries.

This week, Alcoa Inc. and Intel Corp. are expected to report markedly higher profits for the final quarter of 2010. Overall, fourth-quarter profits are projected to jump 9.8% from a year ago, continuing the streak of rising earnings that helped send the Dow Jones Industrial Average this month to levels not seen since May 2008.

But barring an unexpected acceleration in the economy, industries such as airlines, food, construction and telecommunications that have lagged the recovery, could remain under pressure. The airline industry, for instance, just posted its first full year of profit in four years, but now faces sharply higher costs for jet fuel and labor pressures.

Stocks have been rallying almost unabated since March 2009. Bonds have been rallying too. Those two assets are telling two very different stories. In the stock market, it’s recovery time, it’s corporate America getting back to doing what it does best, produce profits for its owners. In the bond market, it’s a much darker vision, it’s a slide into recession, renewed banking crises, terrorist attacks. Those are two very competing visions, but if you just follow where the money’s going, you can see which story has more currency with the investing public.

From the Journal:

The stock market just posted its best September in decades, but hardly anyone seems to be joining the rally. Hedge funds, high-frequency trading firms and individual investors have all cut back on stock trading, leaving third-quarter trading volume 25% below the level in the second quarter.

Trading on the New York Stock Exchange, the Nasdaq Stock Market and the American Stock Exchange is averaging 7.1 billion shares a day for the past three months, far below the 2010 average of 8.8 billion shares a day and back to levels not seen in more than two years.

I’ve had this sense lately that the stock market isn’t actually telling us much. Oh, it’s telling us that corporate America is healthy again, but you don’t need the stock market to tell you that. Just look at the earnings reports.

The stock market has this hold in the popular imagination, and when it’s rising, most people assume that means the economy is doing well. The stock market is telling corporate America’s going to post record profits over the next year. Yet Americans’ wages are flat, when 15 million people are out of work, when thousands of people are exhausting even two years of jobless benefits and tumbling into oblivion. It seems there’s a disconnect between the real world and the stock market.

There is no disconnect, however, between the real world and the bond market, and that’s where the money’s going.

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I’m not the only one who thinks the economy’s worse off than conventional wisdom says. In his weekly commentary, John Hussman digs through the public database of the NBER, and concludes the economy is still struggling, and with stimulus fading, there’s very little to keep the recovery alive.

Given the data in hand, it’s clear that past growth downturns of the same extent have often gone on to become recessions. However, there are a few exceptions where these growth rates dipped below zero and then recovered. If we had good reason to expect positive economic tailwinds, we would be less concerned about the present deterioration. Unfortunately, my impression is that the bulk of the growth that we did observe coming off of the June 2009 economic low was driven by a burst of stimulus spending coupled with a variety of programs to pull economic activity forward. My concern is that these synthetic factors are now trailing off, with little intrinsic economic activity to carry a recovery forward.

Suffice it to say that we’re not yet out of the woods.

You think that’s why the Fed’s laying the ground work for QE2? They’re not dumb; they know the economy’s still on fragile, far more fragile then they’re letting on, and there’s no political will for more stimulus spending. You can bemoan the national debt, you can rail against “socialists” in the White House, but don’t for a second think this recovery has been anything organic.

It’s all been government juiced, whether it be Congress, the White House, the Fed, or Congress leaning on the FASB to suspend mark-to-market accounting rules. Now, the NBER doesn’t differentiate between public spending and private spending; to them, growth is growth. But the Fed knows better. The Fed knows this economy can’t stand on its own yet. The Fed knows what the man on the street knows: the economy stinks.

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Stocks have been getting quite the lift from both the election cycle and the Fed’s loose money policies, while mixed economic data have been just encouraging enough to keep the bulls contented. This allowed stocks to craft a technical break-out, and sans some game-changing bit of news, it may hold through at least election day.

Hold is about what they’re doing today; futures up a hair on a relatively quiet morning. Wal-Mart offering $4.6B for South Africa’s Massmart and Unilever in a deal for Alberto-Culver. Dallas, Richmond Kansas City Feds post regional surveys this week. Chicago PMI on Thursday. Final reading on 2Q GDP comes Thursday, ISM manufacturing survey comes Friday.

S&P 500 futures up 1.30, DJ futures up 16. Ten-year yield at 2.55%, euro’s flat at $1.3492, although it was weaker earlier.

I opined on Friday’s News Hub that the election cycle, and the Fed, were driving things here, and there’s an article in today’s Journal that bears out at least the former. We’ve been hearing for some time that traders are looking to the election, and the widespread notion that the GOP will take back at least one or even both houses of Congress. E.S. Browning says, in fact, the market is already pricing it in:

Investors are debating whether the November election will have an impact on the stock market. Actually, it probably already has.

In election years, the stock market typically hits a roadblock in the first half of the year, as investors worry about the looming vote. But money managers typically are looking three to six months ahead when making investment decisions, and by summer they are forced to start looking past the November vote. Much of the election rally can take place before the outcome is known, as investors worry less about the looming election and focus on the coming year.

The thinking on the Street seems to be that the GOP is more business-friendly, for one thing, and will act as a counterweight to the “anti-business” Obama administration (although it’s beyond me how any party that would front that monument to appeasement called the Dodd-Frank Bill could be described as “anti-business.”) Maybe. But this isn’t necessarily a moment in history that will benefit from gridlock. If the GOP, which apparently stands for “Glenn Or Palin” these days, just grinds Washington down to a halt, we will be even worse off for it.

Miller Tabak’s Dan Greenhaus makes the point:

We cannot envision gridlock being good for markets or the economy at this point in time. Will there be a halt to some policies the market perceives as harmful? Of course. But with the economic realignment ongoing, the country would be served by a rectilinear and somewhat unified Congress. We hope that the decision making process becomes more unified from here, but the probability of such unification remains less than absolute.

I’m not saying the Dems have all the answers; Lord knows they don’t. But this idea that a Republican victory in November is going to be a panacea is just so much GOP pablum.

It's just an extended pause. But we'll have to operate immediately.

Wall Street loves to come up with euphemisms for “crappy.” Remember Goldilocks? Back before the housing implosion, before the credit crisis, back when everybody really knew things were coming unglued but nobody wanted to admit it, the big theme was Goldilocks — not too hot, not too cold. The Street convinced itself that Ben Bernanke could glide the economy into a “soft landing.”

People actually believed that.

So today, as the economy teeters on the edge, talk of deflation and the Hindenburg is in the air, as even the bulls are having to concede that the right-hand side of the V in their V-shaped recovery has collapsed, the Street’s coming up with another batch of euphemisms, as our colleague Kristina Peterson writes in today’s Journal.

For a time the market was worried about the possibility of a “double dip” recession. But those worries were kept in check by advocates of a simple “soft patch” in the economy.

Now, even optimistic investors seem to be settling in for what they are calling an “extended pause” in the recovery. They worry than an economy on hold could keep the market trapped in its trading range or drag it down further, adding more losses to the benchmark indexes’ year-to-date declines.

Extended pause. You know, a coma’s an extended pause, when you think about it.

Lastly, one of the posters on Kristina’s article online linked (gratitously as it turns out, since it’s a link to his own article, but still, sort of interesting) to a blog post about how generational shifts are largely behind the shift in the economy.

The big fear among traders yesterday, Friday the 13th on your Gregorian calendar, wasn’t Jason Voorhees, it was the “Hindenburg Omen.” Steve and Tomi Kilgore penned a piece for today’s Journal that discusses the omen, the mathematician who created it, and what it might, or might not, mean for the stock market.

It’s a good read, although judging by some of the comments on the story on WSJ.com, some people are taking it a bit too seriously. But go read the whole thing yourself (subscription required, it’s behind the paywall.) At the least, you’ll get a sense of what’s preoccupying the market these days. It ain’t those “stellar” second-quarter earnings.

Forget about Friday the 13th. Many on Wall Street took to whispering about an even scarier phenomenon—the “Hindenburg Omen.”

The Omen, named after the famous German airship in 1937 that crashed in Lakehurst, N.J., is a technical indicator that foreshadows not just a bear market but a stock-market crash. Its creator, a blind mathematician named Jim Miekka, said his indicator is now predicting a market meltdown in September.

Wall Street has been abuzz about whether the Hindenburg Omen will come to bear, with some traders cautioning clients about the indicator and blogs pondering all the doom and gloom.

The tidbit I love is that a partner of Miekka’s coined the name – because “Titanic” was already taken. I have to admit, I hadn’t heard of the “Titanic Syndome” before, but here’s a post at Safehaven dated Oct. 22, 2007, that discusses both it and the Hindenburg Omen.

The all-time high for both the DJIA and S&P 500 was recorded on Oct. 9, 2007, incidentally. A few of the comments on WSJ.com asked how the Omen did during that time frame. Pretty good, right?

Now, even Steve’s article makes it clear the Omen isn’t a lock predictor; nothing is. All of these kinds of things are just people trying to uncover patterns that could point to one possible direction stocks might travel in the future. But it is a red flag. Plug it into your thinking, along with everything else you’re seeing out there, and make your own decisions.

(Photo: Wikimedia Commons)

Falling prices aren't the same as sale prices.

Remember that scene in the first “Die Hard” (and the best one (well, the only really good one, I mean, the others are passable, except for that fourth one, but really, the first is a top-rate action movie, the others are just rehashed leftovers,) where John McClane throws the dead terrorist out of the window and the body plops down on the hood of the police cruiser that’s passing by, and McClane leans out the window, already a dirty, bloody mess with a machine gun in his hands, and screams “Welcome to the party, pal!”

That was the first thing that came into my head when I saw this Phil Izzo story (and that probably says something about me, but let’s leave that for some other blog) hit the Tape.

It appears that Wall Street economists, by a two-to-one margin, now believe that deflation is a bigger threat than inflation. So, for all the jawboning the Fed’s been doing about inflation, a con game they are likely to maintain this afternoon, Wall Street’s not buying it anymore.

A Wall Street Journal survey found that by a two-to-one margin Wall Street economists see deflation as a bigger threat to the U.S. economy over the next three years than inflation.

“Deflation is dangerously close,” said David Resler of Nomura Securities, one of 53 economists surveyed by the Wall Street Journal. Among economists who answered the question, nearly two-thirds said that deflation poses the bigger risk to the economy over the next three years; the remainder said inflation is the bigger threat. That compares to an April survey, when the economists were split 50/50 over whether inflation or disinflation posed the bigger risk over the next year.

I honestly don’t have much new to say about this; well, anything actually. We’ve been banging the drum on this topic for a long time. It’s just sort of, well, satisfying to see Wall Street coming over to our way of thinking. Even if the thoughts themselves are frankly depressing and even frightening. But you’ve got to face up to reality before you can start dealing with the situation.

Listen, I know what you’re thinking. Utilities? You start falling asleep somewhere between the first t and the third i. But the utilities industry is a reflection of consumer and industrial demand for power, which in turn is a reflection of the relative economic strength of the nation. Given that, today’s Upshot column is actually quite an interesting look at what the electric companies are saying about their business, and what that says about the state of our economy.

From today’s Upshot:

Second-quarter earnings season has been strong overall, and very good for some sectors, such as financial and industrial companies. It hasn’t been as strong for a group that in many ways helps America go, and that’s utilities.

Utilities keep the lights on for the nation’s homes, factories and small businesses, and as such offer a particular insight into the state of the economy’s rebound. The image emerging from the utilities’ second quarter is of a patchwork recovery and generally cautious tone from the industry.

“Consumer confidence is low. Retail spending is low and many of the things that we look at and control, those decisions are telling us let’s be Midwest conservative, and that’s exactly what we intend to do,” said Michael Morris, chief executive at American Electric Power Co., during a conference call last week.