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Disconnect Between Corporate Earnings & Market Sentiment


Parsad
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Very interesting how virtually every investment manager and every investor has become their own little macroeconomic forecaster, while one company after another continues to indicate improved earnings, reduced operational costs, and decreasing leverage.  There is a very real disconnect between what is happening within corporations and actual market sentiment. 

 

As fear of the global economy, the boogy-men of inflation & deflation, and the demise of a multitude of currencies permeate investor's minds, we have a very real cash hoard growing around the world with fundamentals moving strongly in favor of equities for the long-term.  Methinks we are closer to 1982 than 1977.  Perhaps a couple more years of a stagnant market, while market valutions for many quality companies get better and better.  And for bond, treasury and gold investors...well!  Cheers!

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I've invested my money with a view of no growth for the next 5-10 years. The hangover is going to be long, if it's not long then we will have a third drunk fest and the consequences that come with it. It's funny how a lot of people delusion themselves that 20 years of drinking can be cured in 1 year of sobering up...

 

BeerBaron

 

 

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Guest Bronco

There is only one solution my friends (for the US).  Cut the corporate tax rate to 10 to 15 percent.  You wouldn't even lose tax revenue, with the onslaught of massive job creation AND a giant new tax base.

 

Spend any time in corporate finance and this is plain as day to see.  But our politicians, both parties included, suck. 

 

By the way, this point addresses the prior point of fear and unemployment. We can't move forward until we relieve these clown politicians. 

 

 

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I think everytime we have a period of economic stagnation, investors always say its different this time.  During the credit crisis as everything seized up, the severity was far worse than many other such periods, but I think we are definitely moving in the right direction and things are improving...albeit slowly...not unlike a waterbuffalo squeezing through the belly of a python. 

 

Jobs won't be created overnight, debts won't be paid overnight, but the U.S. continues to own the best educational systems, free market system, and entrepreneurs in the world.  The engine is flooded, but it will slowly start to sputter over time.  Stronger balance sheets in the private sector will spur more jobs. 

 

Unfortunately, as things stagnate for a while, the pessimism will become more frothy.  Nonetheless, investors uncertainty is, as always, is creating undervalued securities which will be missed by many.  Cheers!

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Guest Bronco

Parsad, would you be as optimistic and happy if we shipped Chris Dodd, Barney Frank, and Nancy Pelosi up north!

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Are you kidding me? The US is less innovative than China and India.  How many Chinese and Indian innovations do you use?  The system that has been developed here (US/Canada/UK) is the most innovative in the world and based upon decentralized control versus centralized control.  We have the easiest market to enter (which protects innovation so the inventor will be compensated) and competition makes the goods that trade here the best in the world.  Biotech research, alternative energy and many other types of research is performed everyday.  Just because we can't see where the innovation will come from doesn't mean it will not happen.  It was the same in the 1970s/1980s.  Not many people though the PC would revolutionize the world in the 1970s/80s.  

 

Would you want to develop these innovations in China and India and have the gov't make your share the wealth and your innovation with the state?  In addition, in both of these state capitalist systems (planned innovation) are efficient at catching up, providing commodity factory services and engineering of existing systems (more similar to the early days of Japan/S.Korea) but when new unplanned innovation is required, these systems will fail.  In addition, China is on a treadmill (it needs to create jobs for the gov't not be overthrown) that will eventually fail.  That I think explains many of their actions with Iran and many other questionable nations.

 

Packer  

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Forget the political views - no admin is going to get 1/2 the unemployed population to work in months no matter what the plan is.

There are currently 2-3x as many unemployed as there were in any year in the last decade. The only time you will find anything close to this level (in numbers) of unemployment you have to go back to the early 80s and we currently are at 40% more than that time period. Fortunately (at that time) there was no where to go but up (meaning down)in monetary policy and a young baby boom generation with a real need for consumer products. Today, we have the opposite in alot of ways.

Im not trying to be doom and gloom but i like to be a realist. Are there Companys that are trading in low multiples that should have decent earnings in the years to come? Yes, but not many. As ive said before, I just keep my cash in my pocket till the opportunities are essentially begging me to buy.

What we currently have is surplus in capacity and durables brought on by the exhuberant and intoxicating decade and until that dries up it will be tough sledding.

Dpnt shoot this messenger ;)

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Forget the political views - no admin is going to get 1/2 the unemployed population to work in months no matter what the plan is.

There are currently 2-3x as many unemployed as there were in any year in the last decade. The only time you will find anything close to this level (in numbers) of unemployment you have to go back to the early 80s and we currently are at 40% more than that time period. Fortunately (at that time) there was no where to go but up in monetary policy and a young baby boom generation with a real need for consumer products. Today, we have the opposite in alot of ways.

Im not trying to be doom and gloom but i like to be a realist. Are there Companys that are trading in low multiples that should have decent earnings in the years to come? Yes, but not many. As ive said before, I just keep my cash in my pocket till the opportunities are essentially begging me to buy.

What we currently have is surplus in capacity and durables brought on by the exhuberant and intoxicating decade and until that dries up it will be tough sledding.

Dpnt shoot this messenger ;)

 

You've struck a very crucial point that the OP missed: the difference between the 80's and now?  Interest rates.  We went from all time high interest rates to all time low.  I don't know how else the Feds will be able to squeak more growth out of the US.  Also, with all the talks of austerity here and abroad, growth may be crimped even more. 

 

 

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I am not that optimistic.  Overall corporate earnings are good but what percentage of the increase in corporate earnings is non-financial?  Crunch those numbers and then let's talk about whether corporate earnings are good.

 

I think if you look at virtually any company in the S&P500 or the Dow, their balance sheet and quality of earnings has improved over the last year and a half.  Revenues may not have increased because demand is still low, but operationally most companies are operating at much more efficient levels.  The heart attack patient is now walking 3-5 miles a day, but not running yet!

 

The biggest thing I can point out to is that corporate balance sheets now have a higher percentage in liquid assets than at anytime since the 1960's.  With zero or near-zero interest rates, where is all that money going to go?  Dividends, share buybacks, debt reduction, acquisitions and eventually operations as demand ramps up over time.  Private equity and hedge funds are also holding a ton of cash.  Pension plans, endowment plans, financial institutions, you name it...the world is awash with cash in a zero-interest rate environment.  When that sentiment turns, and it may be 6 months or 2 years, who knows...but it will turn hard!  It always does.  Cheers!

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The trick is what is everyone doing with their money. Currently, I am still 30% invested (largely US large cap) and 70% cash. So I am being very cautious right now.

 

Yes, well run companies look cheap but that does not mean they will not get cheaper. Regarding earnings, if you looked simply at NET EARNINGS I am not so sure that the overall market is as cheap as it looks. And with unemployment as high as it is I am not sure where future net earnings are going to come from.

 

I do like to look at the macro. I also have learned to stay focussed on being disciplined: buy well run companies trading at a great price. That continues to be my focus now.... read, read, read and wait for price to cooperate... 

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Guest dealraker

Life could be worse than sitting around with stagnant priced high quality us stocks yielding 3 1/2% in a near lower inflation count.

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kumar I apologize must have read more into your comments than you suggested.  I think what many are missing is that we have been in a bear sideways market for 10 - 11 years already.  Large caps have good yields versus interest rates (which you could not say in the early 80s) and there are some compelling smaller firms that I just cannot believe are trading at the multiples they are (this is the cheapest multiples on a FCF basis I have seen.  Some examples, SALM (a small radio company with a large component (50%+) of block programming - consistent recurring revenue) trading for 2.4x FCF or SGA (a mid-sized radio/TV operator) trading at 4.2x FCF and these firms have very modest amounts of debt. Higher but still supportable debt level include ETM (3.7x FCF) and ROIAK (5.0x FCF).  Then you have cable/TV with SBGI (3.9x FCF) and SURW (3.5x FCF) and LNET (2.0x FCF) all with reasonable debt levels.  If you don't like these, try some entertainment names like NASCAR track operator TRK (5.1x FCF) or slot machine maker MGAM (3.9x FCF).  Then there are some with more downside risk due to market erosion (newspaper) like GCI (3.5x FCF) and MNI (1.4x FCF).  These are all firms with low capital requirements and high ROICs.  The downside to these is if we go into GD 2 these firms may have some problems which I doubt we will.  Then there is rural telecom with FTR (5.1x FCF) Q (5.1 x FCF), LICT (4.1x FCF) and CIBL (1.7x FCF).  Then there is insurance (Harry's rankings ) - SUR @ 19 to 23% return/yr on MV of equity, NATL @ 18% to 23% return/yr, Lancashire @ 19% return/yr on MV of equity and FFH @ 18% return on MV of equity.  Then there are real estate/infrastructure firms who are growing CF nicely have good prospects and are selling at a discount to NAV like BAM (10% CF yield & 33% disc to NAV) and Wheelock (22% earnings yield & 43% disc to NAV).  These are just in the US.  For the bears, what is the reason you are bearish?  Macro or are you not finding cheap stocks?  If is macro, I would submit that it is impossible to predict this and you should focus on the bargains out there.  Since the macro hurt the markets last time, I think folks are too focused on it this time.

 

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Looking at Shiller's data, in a historical sense, the broad market is still over-valued.  The degree of over-valuation is much more acceptable now than it was in the decade or so leading up to the financial crisis, but they're still higher than historical norms (my calcs suggest that it is somewhere between 12% and 34% higher than historical averages....).

 

However, despite the modest broad market overvaluation, as we have discussed on this board there are currently a number of compelling large cap opportunities.  It is possible to buy WMT, JNJ, MCD or even KO at earnings-yields that are reasonable and with some prospect of modest earnings growth.  IMO, all four of those companies have a solid 5 or 10 year outlook.  You won't necessarily make 20% returns annuallized, but you might be near 10%.  In an overvalued market, it's nice to have that option.

 

As a final observation, if you are a believer in Siegel's Constant, a ~10% annualized return from these very large-caps is pretty good in a zero-inflation world.

 

SJ

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Guest misterstockwell

I see several things that make me nervous. First off, the market is broken, mechanically. The quants rule the day now, and we are all subject to their whims. If we can lose 10% in 15 minutes, things are not right. This spooks the normal investor out of the market. I watch my individual stocks get pimped around by the HAL9000's and it doesn't fill me with confidence. It will end badly. I have a friend that is a partner in a HFT firm. They do ONE MILLION trades per day, with an average holding period measured in NANOseconds(his words). They do 90% of their trades at the same price, relying on a quarter cent payment from the exchanges. As he tells me, "by the time a quote arrives at your desktop, we have done 1,000 trades on that info." This is not fair. His disaster scenario? "Cut my fiber. Then we have thousands of trades out, and no idea what our position might be." On mini crash day, they hit the stop-all-trades button and pulled out. So did all his cohorts. Zero bids. No true liquidity. This will end badly.

 

Corporations are lean and mean, but they got there with a hatchet. There is no recovery without employment and housing recovery. Neither are anywhere close to "coming back." Real estate is heading completely in the wrong direction.

 

I like to follow the folks at ECRI who are the only economists that get things correct. Their leading index has headed straight down lately. Not a good sign.

 

The last thing that makes me nervous is government. The current administration sucks, and is not good for a recovery, plain and simple. More regulation, more taxes, more debt, more idiotic programs to help those struggling--they suck. Local and state governments are going to need massive assistance(and taxes) as well. Headwinds abound.

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While I agree for example with the concerns presented by Misterstockwell, I am confused at this point.

 

I would think that at every economic depth that people could not imagine a way out: early 80's, in the 30's. Even after the 2001 recession, I had a hard time seeing better days ahead.

 

On the other hand, there was no "special" program on CNBC at 6 pm on March 9, 2009 to announce the end of the bear market while we had one in early July following a large up day. I see a lot of pumping these days whenever there is a company beating its estimates.

 

It is also true that valuations on some companies are quite attractive, but so were they in 2008 just before the earnings vanished with the recession. I only have to look at the ECRI numbers every Friday which are now pointing to a recession to question what I am looking at.

 

I am also confused by Sanjeev. Unless I am mistaken Sanjeev, you sounded anyway quite bearish earlier this year and late last year at about the same level for the S&P. What has changed?

 

Cardboard

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I often think about Peter Lynch's statement in One up on wall street where he said:

 

from an investors perspective spending 15 minutes a year focused on macro economic issues is a wast of 10 minutes time.

 

That said I have been drawn into macro issues more in the last 2 years then at any other time in my investing career.

 

I would also ask the question about corporate earning improvement, Yes they have improved but in comparison to what? if you are comparing their great increases over last year then is that really much of an accomplishment?

 

It would be interesting if someone put together an index of the strength of corporate balance sheets using an Index of US companies.

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While I agree for example with the concerns presented by Misterstockwell, I am confused at this point.

 

 

 

It is also true that valuations on some companies are quite attractive, but so were they in 2008 just before the earnings vanished with the recession. I only have to look at the ECRI numbers every Friday which are now pointing to a recession to question what I am looking at.

 

 

I wonder how many people will remember the thread we had going on then about this very subject?

 

Im happy with my decisions.

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Guest Bronco

I agree with the user that posted the US Govt sucks.  It is horrible.  It is one thing to make mistakes, but it is another to make permanent mistakes (i.e. social security, medicare, now health care).  

 

I got news for my U.S. friends .... it is called the VAT.  

 

I am actually ok with these quants.  If they can give me PG at $40, I'll take it.  But of course the government will come in and reverse my trade, so let me think about that one...

 

My own opinion is that we will have 2 - 3 years of deleveraging, or what I call inflation allocated towards debt.  After that, we will begin a new and massive inflation campaign.  Oil, gas, food, they will all go up.  And by that, I mean in US $$$.  No other way to get around the mess we made...drill baby drill...no wait...print baby print.  Print money as fast as we can.  The policies we have implemented are irreversable.  It is a mess.  Only way out is to inflate.  

 

I am not a gold bug, but I can certainly see an explosion in that 3 - 4 year time frame (after deleveraging).

 

I think if the government is stable, Brazil will be the place.  They own it all, oil, soy, minerals.  Tough to screw that up.  Plus the Olympics.  

 

I think another country to be in is Switzerland.  If you haven't noticed, all our great U.S. multinationals build a big presence over there.  Tax rates are less than 10%.  European operations are run out of Switzerland.  And even better, no Euro!  They will do well.

 

Just my opinion and prediction - so it is probably worth less than a $500 call option on Biglari Holdings.  But good luck to all.

 

 

 

 

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Guest misterstockwell

why would a value investor care if, and I have grave doubts, the market is "broken mechanically"? are you not able to buy the stocks you like? are you not able to sell the stocks you don't like? See as a value investor I love seeing other value investors focus on this stuff. it means they aren't spending time valuing stuff.

 

Sometimes I am able to buy and sell stocks, sometimes not. I do all my own trades for all my clients, and have been doing so for 15 years. That means millions of shares in that time. I know how to buy and sell. The HAL9000's cost me a great deal of money now. Do you pay attention to how orders fill? Do you see all the flash bids/asks that appear and disappear? There is no liquidity except what the quants want to provide. It costs us all a great deal of money. Try selling or buying a large amount of stock without outsized movements. It can't be done anymore. The HAL9000's sniff it out and go with it.  You can take the attitue that "I am a value investor, why do I care about all this nonsense, long term, blah blah blah," but that doesn't cut it. I have watched our largest holding go from 14 to 11 in a matter of minutes, with bids evaporating faster than a quote system can update. Even value investors place stops, and I am sure some were washed out. Within minutes, it's back to 14. No news. No rumors. CFO has no clue, and NASDAQ has no clue. Knight Trading is the conduit, but they have no idea. This type of action, or even the mini-crash, washes out more and more investors each day.  I know so many people who are gone from the market because of this crazy activity. You will never realize value if there is nobody left but the quants.

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I often think about Peter Lynch's statement in One up on wall street where he said:

 

from an investors perspective spending 15 minutes a year focused on macro economic issues is a wast of 10 minutes time.

Most of the macro analysis is akin to reading tea leaves.

 

However, I think there are a few measures that can be used as a guide to measuring the affordability of the market.

 

The first is the historic P/E ratio. Markets tend to be dear when the ratio is close to 20, and cheap when it's closer to 10. This ratio isn't foolproof - see the Great Depression.

 

The second is size of the stock market compared to an economies GDP. Gurufocus actively maintain this metric for the United States. Buffett has never stated it, but I believe this is the metric he uses when evaluating a market.

 

Finally, you simply cannot ignore credit conditions in an economy. Private sector/public sector debt, M3, etc. This kind of data is usually more fuzzy, but the trends are useful. Other than those things, I wouldn't usually apply macro factors to investment decisions.

 

I would be interested to read what other metrics value investors use. Parsad?

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