It's All About Earnings

For the past week we have been getting strong economic numbers from all the government reports. This is very positive for future growth as the economy surely looks like the worst may be over. However, the financial crisis still has risks with commercial real estate being the most obvious future problem. Perhaps there are some real green shoots out there but don't forget unemployment continues to rise and we expect it to move into solid double digit numbers.



Most companies that have reported second quarter numbers have beat Wall Street earnings expectations. It is easy to see why the banks have done very well as their cost of funds are negligible. If you can't reach profitability when your cost is zero, the future should be pretty cloudy for banks. Certainly Citigroup remains a disappointment and other banks will also not do well. The strong will get stronger and Goldman and J.P. Morgan will lead the way.



The markets are soaring as earnings are strong but we still raise the red flag as most companies continue to report weak revenues. Ultimately, sales need to drive profits and cost cutting can only go so far. Investors appear to only care about the bottom line so far as aggressive cost cutting seems to be enough for now. Productivity is likely soaring which is good for future growth and stability. We also expect consumer confidence to rise with stock prices and the stabilization in the economy is also removing the fear in the markets.

Global growth, especially from the China stimulus plan, may be boosting the order flow for many companies but as we have stated in the past, some of the Chinese commodity buying is for storage and not for current production. The bottom line is that even with great earnings most companies find revenue growth to be tepid and business may not be declining but it certainly is not improving much. The bottom was reached in March but happy days may not be here yet. We may have missed last week's stock market run but the downside concerns are still real. We view our hedged stock positions as a way to be safe rather than sorry. We may not have the same upside but if the growing government debt, the real estate defaults, corporate bankruptcies, and the weakened consumer become the focus of investor attention, then stocks could still see a sharp reversal.

Markets usually foreshadow the future but it is not always accurate for short term moves. Investors seem to be willing to expand P/E ratios as cost cutting boosts earnings but if order rates don't begin to improve and revenues don't begin to grow, then stock multiples may contract and the bullish euphoria may disappear. There are many more companies that need to report earnings and we will focus on industrial enterprises to get a true feel for the economy. Financials should do well this quarter, and large technology companies are well positioned to weather the downturn but leverage remains high in our financial system and all risks have not abated.