VOL. 126 | NO. 134 | Tuesday, July 12, 2011
David Waddell
The Worldly Investor
Global, US Economies Show Paradox
David Waddell
Hooray Hooray! Earnings season is under way. Macro season turned into a nail-biter with double dip talk, riots in Greece, debt limit brinkmanship in the U.S., Chinese bubble banter and oil supply disruptions in the Middle East. Good riddance.
For the next 3-4 weeks our attention will return to corporate fundamentals and the stock market will re-price. Or has it all ready? The recent eight-day 7 percent surge off the lows in June, once ADD traders forgot Greece and remembered earnings season, pushed many sub-indices to new highs. Now expectations require fulfilling. The street expects earnings overall to grow 14 percent for the quarter.
Financial earnings begin arriving next week and will therefore validate or invalidate the pre-season run. Markets appear vulnerable to disappointment, but valuation continues to protect us from anything serious. If results simply meet analyst forecasts, we will still trade at 12.5 times forward earnings and less than 15 times trailing earnings, far less than long term averages.
Markets don’t historically initiate large declines from moments of low valuation. Look for the reports to set trading ranges a bit higher. The current channel ranges from 1,250 to 1,350 for the S&P 500. If earnings fall in line, the new P/E at 1,250 falls below 12 times forward earnings. At 1,300 we get closer to 12.5 times, a level that has previously attracted buyers. If 1,300 becomes the new 1,250, we will have ground the low end of the range higher by 4 percent.
While fundamentals define the lower band, forward sentiment defines the upper band. Any upgrades in sentiment would stretch the upper band. So maintain optimism about the market because everyone is pessimistic about everything else.
But What About … The US cannot create jobs without economic growth. Economists expected 100,000 payroll gains in June while only 18,000 were reported. The headline unemployment number ticked higher to 9.2 percent, down almost imperceptibly from 9.5 a year ago. The jobs market reflects the moribund domestic economic environment, invoking some cries for more monetary assistance from the Fed.
I maintain my view that the laws of diminishing marginal returns prohibit the Fed from doing more. However, fiscal policy has not been exhausted. In light of the debt discussions, another large scale spending stimulus plan seems indigestible. However, repatriation tax holidays, corporate rate cuts, tax cut extensions or broad tax reform all remain within in the armory. Look for more tax related stimulus chatter in coming weeks.
At a minimum expect less enthusiasm around raising them. To reduce the unemployment rate we need to create 150,000-plus jobs monthly, requiring GDP growth above 3 percent. At our current pace of 2 percent, the engine is simply turning too slowly. Look for a build in legislative pressure.
With the global economy growing at 4 percent-plus there is plenty of growth to power corporate profits, but with the U.S. economy growing at 2 percent-minus there is not enough growth to power job creation. Herein lies the paradox of today’s global economy.
David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.