A Closer Look at Recent Upbeat Earnings Announcements - Don’t Believe the Hype

On April 15^th, the U.S. markets rallied, with the DJIA adding more than 250 points (2.08%) and the S&P 500 adding more than 30 points (2.27%). Of course, this brought out the mandatory Wall Street cheerleaders and numerous stories that FINALLY, it appears that the U.S. markets are starting to turn the corner. As could be expected, other major global markets with close ties to the U.S. markets followed suit the following day as they also rallied by about 2% or more. Numerous stories appeared in the media extolling the resiliency of global stock markets and the “upbeat” earnings of U.S. companies that propelled this big one-day rally. Stories soon followed of “super-cycle” bull markets in the U.S. still being intact, and that this one-day rally is the impetus that would propel the U.S. DJIA to 14,000 or possibly even 16,000 points and take the rest of the global stock markets along for the ride. My response? Don’t believe the hype.

If we take a closer look at the headlines that sung the praises of “upbeat” earnings of U.S. companies such as J.P. Morgan, Intel, and Wells Fargo, we’ll discover that the word “upbeat” has been changed in meaning. “Upbeat” in the financial world does not conform to the Webster dictionary definition of “cheerful”, and “optimistic”, but instead has been distorted to mean “bad, but not as bad as the expectations that have been carefully created and molded by CEOs just prior to earnings releases so that earnings can beat expectations”. Even then, this modified definition of upbeat for the expediency of the financial industry may not stand the test of time as most companies still seem to be less than forthcoming about the problems that continue to plague their companies and the overarching economy.

JP Morgan’s 1^st Quarter 2008 profits were cut in half from a year prior, and in fact would have been cut by about 80% were it not for the approximate $1.36 billion they received from the 1^st Quarter 2008 Visa IPO. Yet, no one seemed to care that if you backed out this non-recurring one-time gain for JP Morgan, their profits would have fallen by 80%. The sentiment on Wall Street was, “at least, they’re not losing money.” Thus, despite the less than cheerful and optimistic earnings report, JP Morgan’s earnings release was reported in large part by the financial media to be an upbeat earnings release, and their shares rallied by almost 7% in intra-day trading. Makes you wonder what companies own the mainstream financial media if they are producing headlines calling such earnings reports “upbeat”. Similar arguments could be applied to both Wells Fargo’s and Intel’s earnings press releases as well.

Many stories that circulated in the press regarding Intel’s earnings carried key statements such as the following: “Intel defied predictions by posting 17 percent growth in the Americas last quarter,” yet failed to mention that despite this growth in the Americas, their earnings for the 1^st quarter still dropped on a year-to-year basis. In addition, many financial journalists praised the fact that Intel’s sales forecast topped analysts’ estimates. Voila! We have share price appreciation for Intel. Are you kidding me? The Intel CEO played analysts like a finely tuned violin by implementing the following formula: Undercut expectations of analysts with gloomy reports a couple of weeks before your earnings announcement, manufacture a systemic downgrade in analysts’ expectations, and then surprise them with poor earnings that beat your manufactured especially gloomy outlook.

Then after the aforementioned has been accomplished, wow the thundering sheep herd with declarations of robust future sales forecasts. Short–term bumps higher in ailing stock markets, and even week long rallies, are most often based upon perception and games that are played to fool investors versus solid fundamental economic health. I’ll explain later in this article how the U.S. Federal Reserve is the biggest contributor to this game by creating illusory wealth among investors that isn’t even real due to their highly inflationary monetary bailout plan.

Here are just some of the warning signals that are still being hidden from the public by the sales-driven commercial investment industry:

(1) The U.S. Comptroller General David Walker’s resignation last month in March of 2008 that fueled in part by his frustration regarding his repeatedly ignored warnings to Congress that they must cut their deficit spending. Remember, it was former U.S. Federal Reserve Chairman Alan Greenspan himself who made the comment that “Deficit spending is simply a scheme for the confiscation of wealth.”

(2) The obvious conflict of interest regarding the valuation of massive amounts of complex financial derivatives held on the books of many major global financial corporations. By the way, the global derivative market capitalization is at least ten times as large as the global stock market capitalization. Think of the consequences on global stock markets if just 10%, or even 5%, of the derivatives markets imploded. Many difficult to mark and illiquid financial instruments are currently valued by internal valuation models developed by management executives whose annual bonuses depend on the valuation of the very derivatives they are asked to value. Who really knows if the books of many major financial institutions are really as solid as the picture they present to the public? One must take their word as truth because it is their very earnings announcements that are driving stocks higher in the short-term right now.

As firms like Merrill Lynch have declared massive multi-billion dollar write downs time and time again after declaring that they have declared all the toxic waste on their books, are you really comfortable trusting the word of these executives? I would say that there is an extremely high probability that they are still being less than forthcoming about the true state of their affairs.

(3) The reason for my skepticism above is not only driven by the conflict of interest regarding valuation models, but also due to the fact that the credit rating system in America is a total sham (the reason for this is beyond the scope of this article but the conflict of interest in the credit rating system is well documented to date). Consequently, with quite likely trillions of derivative products backed by financial instruments that are incorrectly rated due to profit-motivated relationships fraught with conflict of interests, when the time comes to actually sell them on the open market, another round of massive write downs is very likely on the way.

(4) There has not been one credible, sustainable solution implemented by the U.S. Federal Reserve or any other Central Bank in response to this grave toxic mix of Credit Default Swaps, Collateralized Debt Obligations, faulty credit ratings, and bad mortgages that are still festering in the global financial system. Every solution thus implemented has only involved the devaluation of currency (and subsequent inflation) or a charade where bad money is temporarily swapped for good money and then later re-introduced into the system after “stability” has been manufactured. Someone please tell me how trying to hide risk, instead of removing it from the system, or inflating currency until kingdom come will solve the problems of risk that still exist in the global financial system?

The last time the U.S. Federal Reserve took the rapid inflationary approach to head off a deep recession was after the dot com crash hit U.S. stock markets in March of 2000. A real estate bubble in the U.S. was artificially manufactured courtesy of the U.S. Feds solely to avoid a deep recession. On many levels, that plan failed, not only because their inflationary monetary policy was directly responsible for creating the housing crisis in the U.S. today, but also because the real estate “wealth” they created to ease the pain of stock market losses was merely illusory and very far from real (I’ll explain below).

In conclusion, there is no doubt that the U.S. Federal Reserve will try to inflate their way out of this problem just as they inflated their way out of the March, 2000 dot com crash by slashing interest rates an unprecedented 12 times in a row. The only problem with this strategy today is that with the Fed Funds rate already sits at 2.25%. Even if by some miracle, they are able to turnaround U.S. stock markets and thus, global stock markets, with their monetary inflation policy, will any investor in traditional markets really benefit? Remember, all major fiat currencies will likely devalue this year due to worldwide inflationary policies that are currently being implemented.

Comments

[DR JOHNAINSWORTH PE]

AS AN INVESTOR WHO IS LONG INTC, I FOUND THIS ARTICLE, FROM MR KIM'S POINT OF VIEW, VERY INTERESTING. I, HOWEVER, DO NOT DEPEND ON ORGANIC GROWTH FROM MY POSITIONS. I, INSTEAD, USE THE POWER OF OPTIONS. THE CALL PREMIUM TRUMPS THE POSIBILITY OF ORGANIC GROWTH OF ANY SHARE THE I HAVE IN A LONG POSITION. WITH INTC, THERE IS ALSO A 2.6% DIVIDEND PAID QUARTERLY. I RECEIVE ENOUGH DIVIDEND TO HAVE A $2,000.00/MONTH CASH FLOW. MY POSITION IN THIS PORTFOLIO WITH INTC IS ONLY 2% OF ITS TOTAL VALUE. THIS LEAVES A GREAT DEAL OF SHARES OF OTHER COMPANIES TO SELL COVERED CALLS AND LET THE PREMIUM BUILD UP. THE YEARLY OBJECTIVE IS TO HAVE A 14.4% RETURN ON CAPITAL VALUE. USING THE RULE OF 72, THE PORTFOLIO DOUBLES IN 5 YEARS. THIS INVESTING SYSTEM GIVES ME THE SECURITY THAT I WILL NEED IN RETIREMENT. IT HAS BEEN, HOWEVER, A LONG PROCESS OF FINANCIAL EDUCATION. I DIRECT THIS LITTLE LESSON OF MY FINANCIAL HEALTH RESPECTFULLY TO ALL OF THOSE HAND RINGERS WHO ARE PAYING ATTENTION TO THE NOISE ON THE VARIOUS MEDIA SOURCES.

THANK YOU FOR THIS RESPONSE FORUM!

[User 130076]

You will never see a article like this on CNBC, the truth is the Federal Reserve is a hugh skam.

[NoFool]

It's so refreshing to hear someone who is not trying to sell everyone the fake news. You hit it right on every angle. No true news rarely get into the mass media these days. When it comes to all the "news" that are fed to us, common investors are pretty much blindfolded and lead to the gallows.

[galewhitaker]

Great article! It seems to me that the institutions are scared to death that the market is going to crash and they are busy pumping the markets so they can suck in retail investors. I think they plan to jump ship and leave the public holding the bag. I don't think the economy/market can go anywhere because of skyrocketing energy prices. High oil prices are disrupting the transportation industry and causing food riots all over the world. It dosen't make sense that the global economy can grow with all this chaos at hand.

Dear Dr. John
No amount of call primiums or dividends is going to make you well if the INTC stock value drops by 50%. Half of the revenue that INTC earns comes directly from the consumer. Consumers are in a serious bind because they can no longer afford to gas up their SUVs and thunder down to the mall. Because of increasing demand the price of gasoline is only going higher. My advice is to sell your INTC and buy some gold coins.

[curious cat]

for years, i beat myself over the head with what should be, as does the young author of this article. currently, i have decided to ride along with what is, instead. if you go to the race track, you can bet on a horse and watch him win or lose. the stock market winners are not betting on horses to win, they are betting that other bettors will agree with them and continue to drive up the price. that being said, i wish everyone reading this would please purchase some xdsl mphase and we can all win! thanks.

[Onecent]

Great article. Besides your points, as the manic lemmings on WS rally this week, there is a total disconnect from the big global picture. Food prices have risen to a point where there have been bread riots in Egypt. The huge increase in rice is going to impact Asia. Thanks to government subsidies and incentives to grow biofuels worldwide food inflation and shortages are going to get severe.

There isn't a day when lay-offs aren't announced here - today it's AT&T. Unemployment especially among the white collar worker is increasing, that's more mortgages at risk and less consumer spending to prop up the economy.

Oh, and, what's not being noted with Google's revenues is that ad revenues have been drifting to the internet as newspaper circulations fall. Retailers aren't spending more on ads. Their results were no measure of the health of the economy.

[globalmacro]

There are probably some good points in this article but I was completely distracted by the pervasive feeling that you are a hard core conspiracy theorist with theories on everything from JFK to UFOs. Yes there are certainly problems with the economy. But the stock market does not go up and down because the media says it should. The stock market goes up when there are more buyers and the market goes down when there are more sellers. There is currently over 3.5T dollars in US money markets earnings a negative real return when you look at currency devaluation and inflation that is probably running a bit higher than the statisics would show. There are many more trillions in sovereign wealth funds waiting to be deployed. India, China, Australia, and Brazil, for example, can barely contain the inflation caused by the obscene GDP growth rates they are currently experiencing. And to top it all of, almost everyone is as bearish as you are. No bear market ever started when everyone was bearish. Recall 2000-2002, when people had to be dragged kicking and screaming from their bullish theories as late as 2002. The reports from Google, IBM, Caterpillar etc.. are not a fluke. We're not in a bear market. And the only recession so far has been in autos, homes, and on Wall Street -- which incidentally is also where all this negativity seems to be coming from. Its not even clear we're in anything but a consumer based slowdown at this point. So, the only thing I'm skeptical of currently is your ability to filter out the random noise coming from Wall Street and focus on what the market is trying to tell you.

[huhdude]

suckers born every second... Your analysis fell on deaf ears.

[icandoitdon]

dr. john:

i've never heard of a stock investor who does not rely on organic growth to make money. i would assert that it simply isn't possible in the long run and this is why: by selling call options against stocks you own, you are giving away unlimited upside in exchange for a modest premium, while retaining all of the downside risk. the downside can be partly mitigated through hedging, but cost of hedging chews up every nickel of premiums you reap from selling calls.

your strategy might work in a rising market but your performance will probably fall well short of an index fund; worse, it is a guaranteed money-loser in a declining market.

[Kunst]

Dr. John, I don't even read posts in ALL CAPS. I just move on to the next one.

[globalmacro]

Dr. John, STICK TO PIANO