In Earnings Season, Who Cares About the Unemployment Rate?

Asset managers focusing on the emerging markets are well aware by now that, in the final analysis, high levels of unemployment and underemployment have hardly any impact on the stock markets. Has the time arrived now for analysts in the U.S. to recognize that a 10% (or higher) jobless rate is no reason to cloud the outlook for equities?

“When judging consumer demand, we limit ourselves to the 200-million-plus urban middle class,” a marketing director of a popular Mumbai listed company emphasized in a television interview yesterday. “We are not concerned, for example, with the millions of workers in the unorganized construction sector, workers who have lost their jobs and gone back to the villages.”

The admittedly cogent argument Indian stock researchers make is that there is one vibrant, “capitalist” India and there is another India which is mired in poverty, and that corporations can continue to make profits by simply ignoring the India “which has been left behind.” For that matter, China, Russia, Brazil and Turkey, to name just a few developing nations, all display the same economic duality. Should one be adding the U.S. to the list?

As the third-quarter earnings season begins, there is widespread concern over the unemployment statistics emanating from any number of once-robust communities. But, while out-of-work citizens certainly do not help the mortgage or consumer-loan segments of the economy, corporations will continue to make profits. After all, 140 million Americans do work, and many of those who don’t are drawing benefits. And hundreds of American corporations are capable of accessing “middle class” markets in the emerging economies.

The challenge in the days ahead lies in scrutinizing the future outlook for corporate profits from this juncture. Since, as a consequence of cost-cutting, asset enhancement exercises, market positioning and technical innovation, the general tone of the earnings season will be positive, investors need to figure out whether corporate balance sheets actually incorporate realistic grounds for optimism with respect to the future.

As a general rule, there will be a marked difference between the factors determining third-quarter performance on one hand and the foundations for sustainability of growth in an uncertain economic environment on the other.

Alcoa Inc. (AA), which kicked off the earnings season yesterday, ended the third quarter with $1.1 billion in cash; half that amount came as a final payment on exiting its Shining Prospect venture. Alcoa’s operating income ($65 million, after tax) from alumina production was boosted, in good part, by a growth in the demand for aluminium and by rising aluminium prices. Alcoa achieved an impressive $375 million in overhead savings and $1.61billion in procurement savings. In the briefest of terms, Alcoa’s management has responded exceedingly well to the aftermath of last year’s global meltdown. But do Alcoa’s third quarter numbers justify accumulating Alcoa shares at current price levels ($14.70)?

In this writer’s view, the Alcoa framework, i.e. no credible insight into the future, will be repeated in one company announcement after another. Therefore, it does not make sense to turn bullish on corporate news.

At the same time, equity prices should face no risks from negative unemployment data. The thousands of desperate, unemployed workers who lined up in downtown Detroit for housing assistance bitterly complained about the Obama Administration’s inability to generate jobs despite the promises made during, and immediately after, the last presidential elections. But, as a Wall Street hedge fund manager asked, “Who cares?”

The risk today stems from the fact that profit forecasts are being exaggerated on insufficient data, and from Wall Street’s refusal to accept that the entire valuation matrix still needs to contend with leverage and overpricing.

Disclosure: No positions in tagged counters.

Comments

[GoochyPuppy:]

Wealth transfer is going exactly as planned. Create unemployment to lower the cost of wages across the board, resulting in a short term improvement in net earnings that will not be sustainable with future lowered demand. But short term results always trump long term consistent results in a speculative market where big money is also the "smart" money.

Oct 08 03:27 PM

[absinop:]

Earnings season is a great time to make money. Both the investor-craving for value and short squeezes can combine to give a profitable pop to stocks whose EA bet estimates, or, even if not, show good top line performance considering the economic recession. Select wisely. But please remember - Sell the Losers, Keep the Winners.

Oct 08 04:20 PM

[WillieBoy:]

I fail to see a broad-based recovery going on in a market where the consumer comprises 70+% of our GDP, is completely tapped out on credit and is not willing to spend. Additionally, jobless statistics belie the reality of the situation. Look around you and talk to your friends, neighbors and family. Everyone has been affected in some way by the employment picture. This market can defy gravity only so long IMHO.

What about commercial real estate having the highest vacancy rate in such a long time. Mom and Pop businesses going out left and right. Wait until banks decide it's time to start writing down these losses. Oh and what about subprime credit problems spreading to the prime lending market. I guess Wall Street is high on fumes of optimism, and their judgement is clouded. When the big players are ready, the selling will be vicious. The Great Depression presents a historic argument of what happens after a Bear Market Rally similar to what we've seen. A lot of fundamentals are being ignored, and this country is losing its status in the global economy right before our eyes. The Dollar, and Gold are evidence.

Oct 08 04:25 PM

[Dialectical...:]

The fallacy in comparing the US to countries like India is that many (most) US companies have built their profitability on consumer spending (and enterprise spending by businesses which in turn are built on consumer spending). So while growing Indian companies can rely on the size of their emerging middle class, many US companies can not withstand the impact of an anemic middle class. Hence the importance of employment since it drives consumer spending. Yes Home Depot, Dell, and Coke can stay in business even with 10% unemployment, but the idea that it is not important to their future whether the nation has a robust class of people spending their paychecks is ludicrous.

Oct 08 10:59 PM

[user497918:]

What a lame argument. Emerging markets have none of the built-in programs for the unemployed. These costs are a gigantic drag on the US economy. We are not a nation of animal herders!

Oct 09 12:09 AM

[Gary A:]

This article could well have been written by Summers or Geithner. The flaw of course is that spending by consumers drives the economy here. That is not true in emerging markets. This lack of spending by consumers will bring both the US and foreign nations to their knees.

The two stooges, Geithner and Summers bailed out the crony banks who don't lend, instead of the crucial consumer who refuses to spend.

Oct 09 02:46 AM

[Venetian Poker:]

To ignore a 10%-plus unemployment rate seems foolish to me. Not to mention, we all know that the *real* story surfaces when you include the underemployed and those who have simply given up.

The bottom line here is that the only way to go back to the good old days is to reinflate the credit bubble. That is NOT going to happen any time soon.

My mother just looked into a small HELOC, and I learned that -- at least in her county -- Chase Bank, for example, is limiting their HELOC LTVs to 60%. SIXTY PERCENT. When I expressed my amazement, the representative told me, "Oh, it's even lower than that in most of Florida."

And we all know that consumers are deleveraging, if not by will, then by force as accounts are closed or credit lines reduced.

None of this is going to change as long as people are either out of work, underemployed, or nervous about their current employment situation. And with a 10%-plus unemployment rate (and more likely a real number of 15-18% when you include the underemployed and those who have given up), we're not about to reignite consumer spending any time soon.

I really do think we're in for a 5-10 year period of near-zero and zero growth. That should put quite a damper on PE ratios, assuming there's any "E" to even consider...

Oct 09 08:50 AM

[JAMES CARLINI:]

If unemployment is not a big deal how come there is so much lobbying by Indian firms to keep H1Bs in the US?

How much does India depend on money coming home from workers working here? I have heard $31 - $32 Billion a year. Maybe it's more.

If unemployment is no big thing to worry about, why are they lobbying? What's $31 Billion? That's $31 Billion that could be re-circulated in this economy.

Funny how so many skirt around this issue.

As to shortages of skilled people, there are many here underemployed and that is the key variable that many worried about consumer spending don't get.

If there was truly a shortage of critically skilled people here - wages would go up and not down. Did I miss something in Economics 101 and Supply and Demand curves??????

It really seems like some analysts and the media did.

Oct 09 09:45 AM

[Mike from NYC:]

For the past 20 years when more and more manufacturing, support centers and technology development was outsourced to foreign lands and profits leaped for many companies, the long term effects were ignored for the USA. There is no free lunch.

American companies are bullish on outsourcing and India and China in particular, but bearish on America. American companies as well as others just want us to buy their foreign made stuff and not provide us with any jobs to pay for it.

The last recovery was jobless and this recovery will be even more so as a result of the outsourcing of so many jobs. When American companies outsourced and our economy began to change from a manufacturing economy to a service economy we were told that new and better jobs would take the place of manufacturing - unfortunately, that's not true. I thought the Dot Com era would be the answer but we saw how that turned out. Now we are promised a 'Green Revolution' will be the highway to new job creation but as I see it it's all BS. Most of the 'green' will be minted overseas as here in the USA so few green products are manufactured, either solar panels or turbines.

I don't know exactly what the long-term implications are but it doesn't look good. Considering 70% of our GDP is driven by consumers . . . you connect the dots.

On Oct 08 03:27 PM GoochyPuppy wrote:

> Wealth transfer is going exactly as planned. Create unemployment
> to lower the cost of wages across the board, resulting in a short
> term improvement in net earnings that will not be sustainable with
> future lowered demand. But short term results always trump long term
> consistent results in a speculative market where big money is also
> the "smart" money.

Oct 09 10:05 AM

[metaforge:]

This guy should change his SA account to "SlumDog" and write about the Indian market. He clearly does not understand the US economy. The analogy is nowhere near close.

Companies now are laying people off & forcing furlough days so they can make earnings, not realizing that in the long run, these workers they are screwing over will no longer be able to buy their products. It's kind of like if you're starving, you go ahead & eat all the seeds you have to live a little longer rather than planting them to get a real crop!

Oct 09 02:24 PM

[Steven Hansen:]

This is a very interesting comment stream and article. i disagree with nothing said - and this should tell you everyone is on a different page.

i know how hard it is to write an article and convey all your thoughts - as well as writing an opinion.

what the author was saying is that the investors are reacting to earnings and not the terrible unemployment. as a businessman, i will tell you they are rationalizing to the new normal - and they will be fairly profitable shortly.

this is the short term fundamental.

the jobs situation is a long term fundamental. it has so many ugly facets - many of which are described above. the biggest problem is a social one - tell me what you do with you kids still living at home, or engaging in underground activities.

the government is responsible for fostering an environment for the expansion of a jobs market. the wrongly believe that money thrown at the economy will expand jobs. we have proven again that this method does not work.

we need to re-evaluate our tax structure, education, regulations, environmental laws, and import regulations to make them pro-jobs.

Oct 10 01:31 AM

[Northstar10000:]

Money should not have gone to any corporations period...
Send every TAX PAYER a check for $83,400 and watch what would have happened. Oh ya we can't watch now the money went elsewhere. Money back to us could have been used to reduce debt and then spending might have started. the banks would have been satisfied and consumers off the hook. Some would have saved it but most would have used it to spend down or eliminate debt. Too late, of course Washington is looking out for you.

Oct 10 01:14 PM

[Northstar10000:]

All the regulation in the world hasn't worked yet and they propose more as we demand more. Listen nut cases, the most regulated markets were the ones that got us into trouble. Stocks, REal estate,
Banks, next will be the bond market. Watch out below as another governent regulated and sponsered lunatic idea hits the fan. Lets get the government even more involved in giving loans to poor people. How about those Detroit LInes of poor Obama voters thinking there is Obama money in the building. Oh ya and got to love the new credit card protection bill. Written by and for the credit card industry while they call it reform. Hi fools and idiots.

Oct 10 01:22 PM

[Northstar10000:]

Just for additional kicks.. Any and I do mean any Health care bill will be written by and for the corporations. Count on it.

Oct 10 01:25 PM

[Dialectical...:]

It's off topic, but I agree. To simply require that all Americans purchase health insurance without doing something (anything!) to bring down the cost of that health insurance substantially is simply a hand-out to the insurance companies. I am a small business owner who employs 40+ service workers. NONE of us have health insurance -- not my employees and not me. The reason is that we can't afford it. I can not pass the cost on to my clients or I would be out of business for competitive reasons, and I can't expect my front line workers to give up 25% of their paycheck to pay for insurance. So simply requiring all of us to "buy it or else" will put people out of work, close down businesses, and put more people on Medicaid. That is exactly the wrong way to bring down costs. Yet I would not be surprised if this ends up happening.


On Oct 10 01:25 PM Northstar10000 wrote:

> Just for additional kicks.. Any and I do mean any Health care bill
> will be written by and for the corporations. Count on it.

Oct 10 03:32 PM

[untrusting ...:]

Steven,
As we have noted before there are ways to deal with US unemployment, but the politicans and the big boys just won't like it because it reduces their take and their self-serving advantages.

It should be relatively easy to enact tax legislation to incentivize US employment and US content. For example create a US small business corp (tax advantaged). If the US corp/business is 95% US employees and 95% US content/goods/service, then give it an ultra low US federal tax rate of 1 or 5%. For example, something like this might even disincent Hollywood from outsourcing animation, graphics, etc offshore, as well as many other companies from outsourcing increasing numbers of US jobs.

Getting the results desired is usually a matter of putting incentives in place that motivate behavior in the desired direction. For example on the executive compensation matter. The President of the US makes about what, $450K/year. In our view it would be pretty hard to argue that any private company job is more difficult or demanding that the President of US. One could dis-incent high executive compensation simply by making any US executive compensation greater than Pres of US (ie. $450K) 100% non-deductible from corporate income tax irregardless of the form of executive compensation. Would that ever happen, of course not because the oligarchs and politicans will never be willing to put in place anything that reduces their influence and growing share of wealth.

US national issues are all resolvable, but not with our present corrupt system of politicans, lobbyists, and oligarchs.


On Oct 10 01:31 AM Steven Hansen wrote:

> This is a very interesting comment stream and article. i disagree
> with nothing said - and this should tell you everyone is on a different
> page.
>
> i know how hard it is to write an article and convey all your thoughts
> - as well as writing an opinion.
>
> what the author was saying is that the investors are reacting to
> earnings and not the terrible unemployment. as a businessman, i will
> tell you they are rationalizing to the new normal - and they will
> be fairly profitable shortly.
>
> this is the short term fundamental.
>
> the jobs situation is a long term fundamental. it has so many ugly
> facets - many of which are described above. the biggest problem is
> a social one - tell me what you do with you kids still living at
> home, or engaging in underground activities.
>
> the government is responsible for fostering an environment for the
> expansion of a jobs market. the wrongly believe that money thrown
> at the economy will expand jobs. we have proven again that this method
> does not work.
>
> we need to re-evaluate our tax structure, education, regulations,
> environmental laws, and import regulations to make them pro-jobs.

Oct 10 08:02 PM

[User 492096:]

It would be much more interesting a stream of comments if authors would stay focused on laying out a cogent argument and minimizing the "commentary". "Listen nut cases" adds very little to the dialogue.

Oct 10 08:05 PM

[Rakesh Saxena:]

I agree, phrases like "Listen nut cases" adds nothing to a dialogue. The simple point I am making is that we will witness a "delink" between the unemployment rate and equity prices, a delink which is common in third world countries. Arguably, the US economy has its own dynamics; but the reasons for the delink need to be addressed on an "unemotional" basis. - Rakesh


On Oct 10 08:05 PM User 492096 wrote:

> It would be much more interesting a stream of comments if authors
> would stay focused on laying out a cogent argument and minimizing
> the "commentary". "Listen nut cases" adds very little to the dialogue.

Oct 11 10:37 AM

[Plant the s...:]

Rakesh,
Most countries experience rapid economic growth when workforce participation increased (US after WWII) and when more women started working.
Don't you think India needs the same dynamic to grow incomes that drive spending and profits.

Oct 14 02:56 PM

[Plant the s...:]

Consumer spending (local or foreign) drive all economies. Countries with export focus (Japan & China) are dependent on the consumers in their export destinations (US & EU), while countries that are more balanced depend on domestic consumers (US & India).

Only 20% of the Indian economy is total of Exports+imports, which has what helped it grow through this recession as more unemployed found employment to make goods as domestic incomes increased and drove domestic consumption (manufacturing) and service consumption increased.


On Oct 09 02:46 AM Gary A wrote:

> This article could well have been written by Summers or Geithner.
> The flaw of course is that spending by consumers drives the economy
> here. That is not true in emerging markets. This lack of spending
> by consumers will bring both the US and foreign nations to their
> knees.
>
> The two stooges, Geithner and Summers bailed out the crony banks
> who don't lend, instead of the crucial consumer who refuses to spend.

Oct 14 03:04 PM