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.