Earnings Reports Threaten to Deflate Balloon Boy Dow

The entire nation followed the news story with great trepidation as it unfolded dramatically before our eyes. What harrowing heights he had risen to! With anxious hearts, we feared the little chap might crash down hard after climbing too high too fast. We are, of course, speaking of the Dow Jones Industrial Average, and its burst above the symbolic 10,000 mark. The Dow broke 10,000 this past week, revisiting the mark for the first time in over a year. Like an old pal last seen on October 3, 2008, we greeted our once earthbound friend with affection. Still, just as soon as we had soared to cloud nine with him, acrophobia set in.

Through the close of trading Friday, the Dow's heroic climb had taken the poor balloon boy 55% above the intraday low he marked on March 9. Year-to-date, the index is up 13.9%, which clearly illustrates the V-shaped market turn from those shaky days we survived in February and March. What is disturbing though is that despite lessons learned, the naive child has seemed to gain courage from his own momentum, rising 377 points the week before last. Yes, he's come quite far, but also quite fast. Therefore, we must ask, is his strange vessel sturdy enough to survive the harsh conditions of the upper atmosphere?

As we admired the great heights our little friend had so boldly reached, we could not help but feel terrified at how high he was, and without a safety net. Even when taking into account the favorable changes to the component companies within all the indexes, where the worst of losers have been replaced by up and comers, the economic environment does not seem to offer enough lift for the high flyer Dow. We expand for the war-beaten: the companies that had been most decimated by the economic catastrophe just endured, would have offered little earnings per share now to justify the index's valuation. Though, when replacing that troubled lot with the next generation of industrialists, we raise the denominator in the Price-to-Earnings equation. Thus, we reduce the P/E ratio and offer foundation for the numerator to grow (read: make you money).

So by replacing the old broken down General Motors (NYSE: GM) and Citigroup (NYSE: C) in the Dow with new names like Cisco Systems (Nasdaq: CSCO) and Travelers (NYSE: TRV), the index gods fortified the Dow's wings. Of course, changes like these were more prominent in the more encompassing and actively managed S&P 500 Index, and so the earnings comparison between old and new components is much more prominent there. The Dow's valuation based on estimated earnings for calendar year 2009, as compiled by First Call/Thomson Financial, shows a P/E ratio of approximately 16. That is not so expensive when compared against the index's value dating back to 2005, but there is of course a new factor in valuation these days... risk. And in the case of the S&P 500, we compare today's apples to yesterday's oranges.

Now given the fly boy's swift rise, many Wall Street guru types (Greek included) warned of impossible expectations heading into the "show me" third quarter earnings period. Thus, as the season wore through this past week, we were shown the door. Even while most stocks have beaten EPS estimates thus far in Q3, those that did not have been punished in trade, versus little gains posted for those companies that beat their numbers.

Banks, and others claiming to be stalwart institutions of consumer finance, offered disturbing bad debt data last week that also threatens the important holiday shopping season. While credit card charge-offs generally stabilized in September, rising delinquencies of 30 days or more portend deterioration in bad loan numbers in the months ahead. Bank of America (NYSE: BAC), the nation's largest lender that recently lost its chief to the guillotine, reported the most troubling data, with charge-offs representing 14.25% of its representative debt outstanding.

So even as the ballooning Dow rose above 10,000 on Wednesday, the wind was being sucked right out of it. The index teetered around the mark both Thursday and Friday, before closing the week at 9,995.91. With more earnings reports threatening to deflate our high-flying friend over the next few weeks, we suspect he's hoping to find a safe place to crash.

Disclosure: No Positions

Comments

[phdinsuntan...:]

the boy is in the attic all the time, same as the real economy, enjoy the hot air and LONG dug FOR A SHORT PLAY.

Oct 19 08:55 AM

[Faisal Humayun:]

There is no doubt that the analyst earnings estimates for the next fiscal are way too optimistic...Thus, when Companies fall below these optimistic numbers, there is bound to be some correction in the markets...

However, there is no concern of another big crash in the markets...At least in the forseeable future...The reason - ample liquidity to support almost all asset classes...

Moreover, any weakness in the markets or the economy will be tackled by more quantitative easing or stimulus packages (which means more money to speculate in the markets)...So over long term, the Dow is set to go higher in nominal terms...

Oct 19 09:00 AM

[SivBum:]

Not all assets, forget those related to housing sector: home builders, furnitures, appliances, mortgage banks, commercial REITs. Also, after ramping up more than 50% since Mar 9th, the highly anticipated correction is due any time, in nominal terms.


On Oct 19 09:00 AM Faisal Humayun wrote:

> There is no doubt that the analyst earnings estimates for the next
> fiscal are way too optimistic...Thus, when Companies fall below these
> optimistic numbers, there is bound to be some correction in the markets...
>
>
> However, there is no concern of another big crash in the markets...At
> least in the forseeable future...The reason - ample liquidity to
> support almost all asset classes...
>
> Moreover, any weakness in the markets or the economy will be tackled
> by more quantitative easing or stimulus packages (which means more
> money to speculate in the markets)...So over long term, the Dow is
> set to go higher in nominal terms...

Oct 19 11:12 AM

[INDRANEEL S...:]

Yes its another bubble in the wings.US China and Japan market are either over valued or some more increment is in the cards.Once the steam is over we will get sell off in these indices which will give opprtunities for fresh buying @ reduced valuation and leverage.The risk at present is too high.So a correction will make not ony reduced risk but will aslo bring some clarity in the market.The over economic outlook is not very impressive and it will take more time for recovery.Fiscal deficit,job loss,conusmer debt,over capacity will slow the pace of growth of these countries.Global investors are skeptical regarding investments.A sell off in the indices will bring them back.In the present scenario it will better to book profits and keep in the sidelines.Once a sell off begins and valuation comes down stock picking will be idle at that time.Those who are planning to pick up stock now should drop their plans and wait for the fundamental and technical correction to begin.

Oct 19 12:33 PM

[Albertarocks:]

With the financial and real estate sectors failing to confirm with new highs while the euphoria builds, I think we all have to be on our toes. Especially in light of the fact that new highs are being attained in the major indexes on volume that's anemic to say the least.

Oct 19 04:42 PM

[elwind45:]

Can this rally continue when short term interest rates rise? Will China face losing money in a falling dollar and pay 100 dollars a barrel for oil?Will the market continue up when the Treasury bills unwind thus stalling the economy and making long paper very attractive? How can anybody believe analyst's forecasts when they are off the reservation too bearish? How can a professional make money in the market when the public has seen the S&P go from 667 to 1100? Has anybody heard any public information on hedge fund redemptions? As for the market not crashing, this rally has been built by selling the dollar to buy YAHOO! Be safe all.

Oct 21 03:26 AM