Market Outlook: Investors Ignore the Real Economy

If you can keep your head when all about you

Are losing theirs and blaming it on you;

If you can trust yourself when all men doubt you

But make allowance for their doubting too;

If you can wait and not be tired by waiting.

- “If”, Rudyard Kipling

In our view, the only thing propping this market up is investor sentiment. Earnings have not improved…. Investing is and has always been about the real economy, and this market is ignoring the hard data.

- Eric Sprott, “It’s the real economy, stupid”, July 2009 Newsletter

The two week run ending July 24th was the best for the Dow since March 2000. Over that same period, the S&P rallied 11.4%. The Nasdaq was on a 12-day winning streak finally broken last Friday.

In the past few weeks, Wall Street strategists have been raising their year end price targets to keep up with the dizzying rise in the S&P 500. Goldman raised its target to 1060 from 940, Credit Suisse to 1050 from 920, HSBC to 1020 from 900 and Barclays to 930 from 760. It’s hard to bet against this market but that remains the right stance in my opinion.

The one earnings report that continues to shock me was Caterpillar’s (CAT) announcement of a 43% drop in revenues in its core Machinery and Engines division. Revenues in this division dropped to $7.3 billion from $12.8 billion a year ago. How can we be having an economic recovery if nobody is buying industrial machinery?

Along the same lines, commercial truck manufacturer Paccar (PCAR) reported a shocking drop in revenues after the close yesterday. Revenues in their core truck division were off 58% from the year ago period - to $1.6 billion from $3.8 billion. Again, how can there be a recovery when transportation companies have no demand for commercial trucks?

I also noted these quotes from Paccar CEO Mark Pigott from the last two earnings releases:

I am very proud of our 17,000 employees who have delivered good performance to our shareholders and customers in today’s very challenging business conditions.

- 1st Quarter Earnings Release, April 28

I am very proud of our 16,000 employees who have delivered good performance to our shareholders and customers in today’s very challenging business conditions.

- 2nd Quarter Earnings Release, July 28

The other earnings report I want to mention was UPS’s (UPS) from last Thursday. Revenues were down 17% and operating income 38% from the year ago period on a 4.7% drop in average daily package volume and a 10.5% drop in average revenue per piece. No wonder they don’t need any new trucks!

Not all of the earnings reports are this bleak. Panera Bread (PNRA) yesterday reported flat same store sales and a 28% increase in net income. Business at AT&T and Verizon continues hold up nicely. Storage hardware maker Western Digital (WDC) yesterday reported essentially flat revenues compared to the year ago period. But the highly cyclical businesses continue to suggest to me a continuing deteriorating in the real economy.

Disney (DIS) reports earnings before the open Thursday and I will be very interested to see the performance at its theme parks and related hotels.

Amidst all the bullishness, it’s worth pointing out that a number of stalwart and venerable bears remain. Check out Eric Sprott’s “It’s the real economy stupid”, David Bernstein’s most recent “Market Thoughts” which John Mauldin writes in the introduction that he agrees with (thanks to reader Joe T for passing that along) and Morgan Stanley Strategist Jason Todd who recommended “selling into” the rally last week.

Weekly Returns (7/20-7/24)

S&P: +4.13%

Wilshire: +4.43%

Top Gun: -1.62%

YTD Returns (through 7/24)

S&P: +8.42%

Wilshire: +10.72%

Top Gun: +8.47%

Comments

[winnersdon'...:]

"How can we be having an economic recovery if nobody is buying industrial machinery?"
"Again, how can there be a recovery when transportation companies have no demand for commercial trucks?"

Greg, remember what's been happening the past 12-18 months. It's been referred to as "financial meltdown, armageddon, etc.etc
by pundits and Obama.

Banks weren't lending... Batta Bing, Botta Bong

Companies shut down their purchasing dept's, then proceeded to lay off their workers. It's as simple as that.

Trucks, dozers, motor homes, cars, boats,houses, and just about anything that you couldn't shove down your throat, sat on the shelves.

Bet you two bits there's a recovery starting Q3 and thereafter.

Jul 30 06:58 AM

[Wesley Mouch:]

Thanks for the article Greg.

But we need to talk. You seem like a smart, well read investor who communicates very well. That is why I feel the need to tell you this right away so that you can correct your thinking and enjoy the kool aid with everyone else.

This has nothing to do with the real economy. It hasn't for some time. This is only about appearances now. Think derivatives and leverage. Help wall street and the media help you. As a financial journalist and economist, you need to find ways to obscure the measurable. For example, stop talking about things that can be directly observed (i.e. vacancy rates). Instead, make up a new metric 5x removed from the process you are writing on (i.e. define a new metric called "CRE congressional interest" as the number of times a member of the house or senate says "commercial". Report on it. Track it. Claim its bullish when it increases. When it drops, say that its third derivitive is looking encouraging)

Stop reading earnings reports so thoroughly. Let CNBC do the analysis for you! "CB Richard Ellis sees a time when businesses may want to inhabit office space again".

Focus on the government statistics. Worry not about seasonal adjustments, enjoy CPI, PPI, and GDP as rawly reported. Debt level scare mongers are just right wing nut jobs who hate America. Express deficits as a fraction of GDP, implying that we could somehow tax the elements of the GDP to increase governmental revenues.

I am glad we could talk, and good luck!

Jul 30 08:41 AM

[Glen L.:]

@Wesley Mouch: great satire, thanks!

That fluttering sound you hear is the sound of roosting chickens.

Jul 30 11:33 AM

[Mad Hedge F...:]

they're certainly smoking something. I thought PIMCO co-CEO Mohamed El-Erian hit the nail on the head when he said that the July stock market rally was nothing more than a sugar high. Skyrocketing unemployment does not create new demand. We are going nowhere without a real housing recovery which is impossible with gun shy lenders. What little improvement we are seeing in the economy stems from unsustainable government spending. If you think the last stimulus package was tough to get through congress, wait until the next one. With three quarters of Q2 earnings out now, it is clear that company managements panicked and shed staff like a fur coat in a New York summer. This produced a string of top line disappointments and bottom line surprises. Companies can’t continue this, unless they want to shrink themselves out of existence. They are gaining weight by eating their seed corn. I think that if you want to go long here you are risking 10-15% to make 2-4%. It doesn’t look like a good risk/reward ratio to me. I prefer the inverse. There’s no law that says you have to trade every day of the year, despite what the brokers say. Better to keep your powder dry and watch the long players inevitably crash and burn.

Jul 30 01:05 PM

[Old Trader:]

"Caterpillar’s (CAT) announcement of a 43% drop in revenues in its core Machinery and Engines division. Revenues in this division dropped to $7.3 billion from $12.8 billion a year ago. How can we be having an economic recovery if nobody is buying industrial machinery?"

"commercial truck manufacturer Paccar (PCAR) reported a shocking drop in revenues after the close yesterday. Revenues in their core truck division were off 58% from the year ago period - to $1.6 billion from $3.8 billion. Again, how can there be a recovery when transportation companies have no demand for commercial trucks?"

"The other earnings report I want to mention was UPS’s (UPS) from last Thursday. Revenues were down 17% and operating income 38% from the year ago period on a 4.7% drop in average daily package volume and a 10.5% drop in average revenue per piece. No wonder they don’t need any new trucks!"

" Panera Bread (PNRA) yesterday reported flat same store sales and a 28% increase in net income. Business at AT&T and Verizon continues hold up nicely."

The economy might be so weak that we have no need for industrial equipment, trucks, or the need to ship much, but at least we can take solace in the BEST damn flatbread sandwiches money can buy, while we're waiting for things to turn around. Perhaps the laid-off workers from Cat, PACCAR, etc. should apply for server positions at Panera. Oh, and btw, by sure to phone in your order on your smart phone to ensure faster service.

Jul 30 05:41 PM

[perceptions...:]

Investors are proceeding on two basic assumptions -
1) Greed is good!
2) It won't be different this time!

However, time may sorely test, both of those assumptions?

Jul 31 07:13 PM