“False Positives”

The markets are still bullish almost 8 months after the March 9th bottom. The Dow closed above 10,000 on October 14th and the bulls have been fighting to stay above it since then. But it has been trending below the ten thousand mark for the last 24 or so days.

The hopes were that earnings for the quarter being reported would be decent. This would give the bulls the ammunition to push the Dow and S&P still higher, well above the 10,000 mark.

So, where is the market going?

The Dow closed on Friday, October 30th, at 9,712 and, despite the run-up in the first half of October, ended up flat; at exactly the point it began the month. The S&P 500 declined from near 1,100 to 1036 on the 30th.

The Dow closed above 10,000 again on Friday, the S&P is pushing eleven hundred again, and they’re roaring ahead today on the heels of a falling dollar.

It is an imperative for the bulls to keep the elusive 10,000 level if there is any hope of the markets rising any higher. Their biggest fear is that the ‘real’ economy will be exposed and the markets will begin a nearly unstoppable collapse. In order to prevent the second leg of the ‘W’ the bulls, analysts, and reporters on CNBC have been using ‘false positives’ to present a more positive picture for the market after the disastrous 4th quarter of 2008.

But the mantra, ‘better than expected,’ is not good enough quarter after quarter and will soon run out of steam. This is the third quarter the financial illuminati have adopted that rallying cry. The ‘false positives’ should have already run their course, given the current economic data. Expectations are extremely low and may be falsifying a perceived recovery.

Are expectations too low?

Though a number of company’s bottom-lines beat consensus estimates, a penny here-eight cents there, revenues have not fared as well. Numerous companies did beat top-line expectations, but most expectations are well below the previous year’s earnings and a lot of companies still missed the easy estimates; some dramatically, some drastically.

Is a beat on the bottom-line more important than revenue growth? More important than employees? More important than the health of a nation?

In April I wrote an Op-Ed to the New York Times entitled, “Better Than Expected.” It was originally submitted on April 7th.

The intent at that time, after a month of a rising stock market, was to point out that better than expected did not reflect the ‘real’ economy, the real numbers.

Despite the continued run-up in the markets—over five months and 40% more since I wrote the article—has the ‘real’ economy improved? Have the fundamentals that drive the market changed? Have the sales and the profits of the corporations in the Dow, S&P, and NASDAQ gotten healthier?

Not really!

Some companies have actually shown ‘real’ improvement. Almost all have gotten much leaner—in healthy ways for the investors, but not for the economy—beating expected per share earnings amid year-over-year declining sales.

In order to see how expectations compare to reality I took a look at the earnings calendar for the week of October 18th, the week in which the largest number of Dow and S&P components report earnings.

It only took a cursory glimpse at the A’s through the C’s to get a comprehensive picture of current expectations. A high percentage of expectations for those reporting this week were low compared to year ago numbers—many well below last year’s earnings for the same quarter. It was similar all the way through the H’s.

The ‘Better Than Expected’ bar was set low enough that a one-legged writer on crutches could jump over it. And that’s what I’m going to do here.

Using the October 18th data as a reference, here are a few of the highlights:

  • A’s – Thirteen (13) companies were scheduled to report during the week. Only two (2) EPS forecasts were higher than the previous year’s reported earnings. Eleven (11) had estimates below last year’s quarter. Seven (7) ranged from 40% lower to as much as 130% below actual earnings in the equivalent quarter.
  • B’s – Fewer companies were scheduled; only five (5) B’s were reporting through the 22nd. Two (2) were right at last year’s EPS and three (3) had consensus EPS’s below last year; Briggs and Stratton was expected to miss by 600 percent.
  • C’s – Of the C’s, fifteen were reported during the week. Five (5) had positive consensus EPS forecasts while ten (10) had lower expectations on a year-over-year basis. Capital One blew away the bottom-line numbers, but Capitol Bancorp had an equal miss to the negative. Capital One had charge-off problems that were ignored in most reports. City National Bank was expected to decline 90% to 8 cents per share from the 74 cents they reported in 2008.

Lower expectations permeated every industry, every sector this quarter as they did the two previous quarters. From financials and banking, to manufacturing; from telecommunications to tech; retail to metals and manure, expectations were ridiculously depressed.

Not a single sector was immune from weak comparisons.

But the 4th Estate, those entrusted with providing pertinent and necessary information would surely expose the weak quality of consensus expectations. Explain that estimates were considerably lower than last year and easy to beat. Explain that most still failed to meet last year’s reported earnings.

Granted, there is tons of information to go over, to evaluate, and to report. So many banks, auto manufacturers, restaurants, oil companies, heavy equipment companies, fertilizer producers and distributors, and insurance companies.

All that information to report and so little time. Let’s take a look at some information that may have eluded the media in this flood of information.

Banks – Fitting that we should start with the banks. Despite billions from TARP, the (Troubled Asset Relief Program), many of the banks are still struggling; some even failing to hit easy consensus estimates.

By far the worst was Bank of New York Mellon. Though they only received $3 billion in TARP funds, this quarter’s earnings were so far off the charts the Treasury and the Fed are still trying to figure the percentage of the miss. BofNY Mellon earned 25 cents in Q3 of 2008. Estimates were for an increase this quarter to 49 cents. Admirable. But they reported a loss of $2.05 per share. An incredible miss; reported all day long!

It wasn’t? Why not?

Two other bad misses in the banking sector were South Financial (-.44 est./-$1.95 actual) and Synovus (-.63 est./-$1.27 actual). They received $347 million and $948 million respectively.

Several other banks had significant misses including: Zions Bank, KeyCorp, SunTrust, and Regions Bank. All received in excess of $1.4 billion each from TARP just one year ago. SunTrust received the biggest chunk of the group—$4.9 billion—yet they had a big miss losing 78 cents per share this quarter. CIT, the largest lender to small businesses in the U.S., filed bankruptcy a week ago. Over a million businesses lost their credit, investors lost their investment, and taxpayers lost the $2.3 billion given to CIT from TARP.

Manure – Thought it would be appropriate to report the minutiae in the fertilizer industry. We’ll spread it around to three fertilizer giants. They all had global difficulties which were reflected in their earnings. Mosaic Company had a profit of $100 million but it was a decline of 92% from the first quarter, 2009. Potash Corp’s earnings declined by 80% year-over-year. And Agrium expected Q3 earnings to be down 90 to 95% from last year’s quarter. Worldwide, fertilizer sales were down and are expected to be down until well into 2010.

But headlines, whether it be fertilizer or cereal producers, continue to report ‘false positives:’ “Brinker Q1 Profit down 34%: EPS Tops Estimates,” “Corning 3Q Profit Falls 16%; Results Beat Estimates,” “Paccar Sees Modest Improvement in 2010 Truck Sales,” despite profit that tumbled 96%. Transportation companies aren’t buying new Kenworths or Peterbilts. This is a basal indicator that the economy struggles to get a solid footing.

Oil – The headline for Exxon Mobil: “3Q Falls 68%; Earnings Miss Analysts Views.” Exxon Mobil was not the only refiner to slide significantly. Valero posted a loss of $489 million; a negative 87 cents a share. Down from the $1.2 billion profit, $2.18 per share a year ago. Analysts expected a loss of just 33 cents. And Sunoco announced the closing of a midwest refinery due to falling demand.

Others – Caterpillar, BNSF, Alcoa, and U.S. Steel all struggled with earnings in the quarter even though most beat analyst’s consensus EPS.

  • U.S. Steel beat 13 analyst’s estimate of 1 cent per share with earnings of 6 cents. That was down considerably from 2008’s $1.67 per share. Sales dropped 61%.
  • Alcoa’s 3Q profit fell 71% but they beat the much lower estimates. Revenue beat the estimate of $4.55 billion. Unreported by the media was the fact that the $4.62 billion was still 33% below revenues last year.
  • Caterpillar is another interesting example of ‘false positives.’ After reporting that third-quarter profit fell 53%, a statement by the company that it had likely seen a bottom sent the stock soaring 5.2%. Earnings for the quarter were 64 cents, considerably down from the $1.39 reported a year earlier. And, revenue fell to $7.3 billion from lofty heights of $12.98 billion last year.
  • When we look at BNSF it is again clear that things aren’t good. Their third-quarter earnings fell 30%. But more telling in the report was the decline in their shipments for the quarter; more specifically two important economic areas. While revenue fell 27% overall, revenue from shipments of consumer products fell 36%, and industrial production revenue, construction and building materials, fell 34%. Shipments were down across the board.

But is anybody listening?

Big retail is scheduled to report this week. WalMart, JC Penney, Kohl’s, Macy’s, and Nordstrom report their quarterly earnings beginning today through Friday. For all intents and purposes the market viewed earnings season over on Friday.

As we enter the 4th quarter will analysts, advisors, reporters and CNBC continue to push ‘better than expected’? More than likely, because the market prefers to ignore what’s really happening in the economy. Corporations will have to work hard to grow their business on the top-line for the fourth quarter. Further cost cutting will come at the peril of the overall economy and the company’s bottom-line.

The economy is still feeling the affects of home foreclosures and a tough housing market, job losses, the beginning of collapsing commercial markets, and a need for an over-leveraged consumer to spend wisely and save for any chance of survival.

Unemployment and the consumer will dictate the ‘real’ economy and eventually the market will have to follow.

And it doesn’t appear that either will be ‘better than expected’ in the coming quarter.

So prepare for another quarter of ‘False Positives.’

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