It has been interesting to compare earnings performance of the S&P500 versus the broader market. On November 3, 2008  Bespoke Investment Group posted an article entitled Q3 Earnings Not All That Bad, showing that year-over-year earnings for the 500 companies of the S&P500 Index were down 5.6% from Q3 2007. But is that an accurate assessment of what is going on in the broader market?

In the fourth week of the Q3 2008 reporting season, with a total of 1837 companies (of the more than 4000 that report earnings on Wall Street) having reported (up from 1056 companies last week), average earnings dropped to -42% (down from -39% last week, -23% two weeks ago and -13% four weeks ago) versus Q3 2007.  This compares to a year-over-year 36% drop in Q2 2008 earnings, a 30% decline for Q1 2008, a fall of 57% for Q4 2007, a 21% drop for Q3 2007 and a 13% jump for Q2 2007. Q3 2008 also marks the fifth quarter that earnings have deteriorated as the season matured.  So far this earnings season, consumer services have seen the greatest declines, with the earnings of 256 companies falling an average 78% from the same quarter last year.

In the last decade, we experienced the growth of the greatest number and size of asset bubbles in history made possible by a bubble in instruments that Warren Buffett has labeled “financial weapons of mass destruction.” Now that this mother of all bubbles is breaking, who can afford to pick up the tab? (For definitions, please see the glossary at the end of the article.)

It is the stuff of which legends are made. A get-together of finance geniuses in 1994 in Florida from JP Morgan (JPM), all brainstorming on ways to increase the amount of money the bank could loan. How could it find a way to free up more capital to loan and make more in fees?

Last week we discussed Robert Shiller’s S&P500 trailing 10-year price earnings ratio that has averaged 16.3 since 1881 and the fact that it had dropped to 15 as of October 10^th.  While we saw prices increase last week and a rise in P/Es, what does the longer-term future hold?

In our next chart, we show annual trailing 10-year P/Es from 1920 to August 2008 using Dr. Shiller’s data. As we see from this chart, every major recession has resulted in P/Es falling below 10 for an extended period of time - lasting decades, not years - typical of secular bear markets. Click to enlarge:

I recently read an article on this site, “Transportation Sector May be Overly Clobbered,” that basically implied that the Dow Jones Transports Average [DJT)]had been “clobbered out of proportion.” There is a common misconception that transports should be doing better in the face of rapidly falling oil prices. Admittedly, the DJ Transports Average has been performing extremely well compared to the overall transportation sector. But is it currently being unfairly punished or is it now in the process of being properly priced?  

The chart below demonstrates this point. The DJT is a cherry picked composite of 20 transport companies that have held up quite well in this recent downturn. The problem for Dow Theorists (who use the DJT and Dow Jones Industrials Average [DJIA] together to confirm trend) is that this fact has created confusion. Until very recently, the DJT has been in a trading range while the DJIA has been falling.

Friday's $700 billion bailout was the latest in a string of attempts to address credit constipation. So what impact have it and past efforts had on markets? We compiled a chart showing when the bailouts were initiated and what happened to the Dow Jones Industrial Average afterward.

As we see from Figure 1, the first time the Fed and government intervened was when Bear Stearns got into serious trouble in the second week of March. The Fed intervened and provided guarantees to JP Morgan (JPM) so a quick deal could be done after close of markets on March 14 - 15, thereby averting what many felt could have caused a financial meltdown. As we see from the chart, it helped the Dow mount a two-month rally that ended in the third week of May.

Trying to find a politician who thinks the next bailout is a bad idea is like looking for the CEO of a bankrupt company willing to forfeit his fat severance package – they are a rare breed indeed. And this time around that rare breed is someone like Alabama Senator Richard Shelby.  In an interview on Bloomberg this week he described the situation, admitting that he is popular on neither side of the aisle. What has made him so unpopular? He refuses to sign on to the $700 billion bank bailout and believes it is a sellout of the American taxpayer.  

A credit crisis is never pleasant. It’s kind of like having a national root canal. But having a credit crisis on the eve of an election is dangerous indeed. Why? Politicians on both sides of the fence have agendas that they generally keep to themselves. But throw them into an election and we quickly learn that these agendas serve one purpose and that is to get elected at all costs.

In the aftermath of the SEC’s decision to finally start enforcing Regulation Short Sales (RegSHO) on July 15 by banning naked short selling in 19 banking and financial stocks, I wrote an article entitled Mother of All Short Squeezes.  In it I made the following comments:

In their monthly Short Interest Report on July 16, Bespoke Investment Group updated their short interest numbers showing that short interest as a percentage of the float continued to increase during the second half of June with the average short interest hitting 6% for the S&P 500. Over the last year, short interest has increased 48% for the 500 stocks.

Like rescuers rushing to help Darwin-award wannabees who ignored dire warnings to evacuate Galveston in the path of Hurricane Ike, federal officials and Wall Street execs worked feverishly Saturday in an attempt to resolve the financial crisis now facing Lehman (LEH).  It is the second ‘big five’ Wall Street brokerage to succumb to the financial tsunami after Bear Stearns, which took $29 billion in federal assistance to make the JP Morgan (JPM) purchase of the company work. But this time officials are doing their level best to convince potential buyers that no bailout should be expected.

It remains to be seen if officials can make this condition stick, but if no buyer steps up to the plate, the government will again have to act as buyer of last resort. Chances for a deal devoid of government-backed guarantees dimmed significantly Sunday when Barclays Bank (BCS), the last remaining bidder, walked away from negotiations increasing the chances of a Lehman bankruptcy.   

September lived up to its terrible reputation in the worst week for stocks since May. It was the worst beginning to the month since World War II according to Bloomberg. But that hasn't stopped an army of pundits from playing their favorite game especially when stocks get clobbered. Bottom picking continues to attract analysts like moths to a flame as they shamelessly, almost desperately talk their books. Attempts to justify their high fees for losing their clients' money shouldn't fool anyone but it probably does if the popularity of this practice is any indication. And the more depressed stocks get, the more intensely they compete in this game.

As I write this, I'm watching Barton Biggs on Bloomberg. "We're pretty close to a bottom," he says, clearly uncomfortable on camera. He believes we are in a cyclical bear market but if it turns out to be a secular bear, ventures that "prices could go lower."

If you’ve been listening to the Street, you will have no doubt heard more talk of a real estate bottom again. Admittedly, there have been a few encouraging signs emerge in the last month. They include an improvement in the rate at which the S&P Case-Shiller 10 and 20-city composite home price indexes have been dropping and signs from a number of regions that prices are actually increasing month-over-month in a few cities (see chart).

In some areas hardest hit, buying foreclosures has become the latest fad and sales figures in areas of California, for example, have experienced impressive increases. How long this continues, however, remains to be seen.

As the economy has cooled and the dollar rallied, crude oil prices have fallen. Lately oil appears to have formed at a minimum, a temporary support base. Whether it will fall further from here or rally remains to be seen but the fundamentals would seem to support firming energy prices. (Be sure to watch these peak oil videos.)

But whatever happens to the price of oil, the price of natural gas relative to oil is at historic lows as pointed out this week by Bespoke Investments. Given that cooler weather will begin to make itself felt in the weeks to come, the prognosis for natural gas looks promising. While oil has lost just over 20% of its value since the end of July, natural gas is down 42% from its peak.

“The truth that survives is simply the lie that is pleasantest to believe.”

H. L. Mencken

Tuesday’s action by the SEC in amending Regulation Short Sales (RegSHO) listed 19 banks and financial companies for which naked shorting was effectively banned for 30 days. Such a limit was long overdue but why limit the restriction to just 19 companies and just 30 days?  

Naked short selling (selling shares short that are not first borrowed, which is required to execute a legal short) is endemic and the SEC has turned a blind eye to it since the agency was created. This recent action is a knee-jerk reaction but a clear example of too little way too late.  The question is will they have the stomach to do what it necessary and give all stocks the same naked short protection? But like anything else, the devil is in the detail.

June 30 marked the end of Q2-08 so we thought it a good time to perform our mid-year U.S. market roundup.

In the first chart, we see how the three major indexes have performed together with the MSCI Emerging Market ETF (EEM) and more than 8,300 U.S. stocks in the VectorVest U.S. Composite Index [VVC]. Large caps have been hard hit by high oil prices and the spreading credit crisis with the overall market that includes small and mid-caps faring slightly better than the blue chips and tech stocks of the NASDAQ.

Based on the recent jumps in homebuilder stocks, investors have again become bullish on the sector. After hitting a low of 117.41 during the week of January 11, 2008 the Philadelphia Housing Index ($HGX) has been rallying. It ended the week of April 25 at 144.16 for an impressive 23% gain. This has had the very predictable consequence of prompting pundits to again call a bottom for builders and the housing market in general.

Before deciding whether this conclusion is justified or just another example of brokers and money managers ‘talking their books,’ let’s take a quick look at the data. John Mauldin made an interesting point is his recent newsletter about the difference between sales and starts. A picture is worth a thousand-word explanation so here are the charts which provide a quick situational snapshot.

At the risk of generalizing, the vast majority of investors are not chart oriented and anytime an article includes a stock chart, they will often move on. But as one great trader and teacher John Bollinger once said, those successful in this game quickly learn to use anything that works, and charts often provide some valuable clues as to where a stock or market is headed.

I must admit to have been struggling with the contention by bullish analysts like Dick Bove (who regularly appears on financial TV) that some stocks, including financials, represent a “once in a generation opportunity to buy.” This is not what my leading sector and fundamental indicators have been flashing, so I have become accustomed to tuning out the raging bulls on CNBC and Bloomberg.

New Zealand interest rates have remained stubbornly high at 8.25% for months, which while not great for domestic borrowers, have been a boon to carry trade investors. This elite group borrows in a low-yield currency to buy debt instruments in a high-yielding economy and pocket the difference as profit. But the cheap source of funds has provided a steady supply of capital to invest in a variety of markets around the globe.

Interest rates in Japan have remained near 0.5% providing carry trade investors with an almost endless supply of cheap funds. As long as the spreads between source and target nations remained high and currencies didn’t fluctuate wildly, the investor pocketed the difference between the two as profit. However, if the target currency [NZD] weakens substantially against the base [JPY] it can spell trouble. As we see from Figure 2, the NZD has weakened versus the JPY substantially since mid 2007. This currency pair is an excellent proxy for the health of the global carry trade.

Here we compare S&P500 (SPY) earnings results with those of the general market. Figure 1 shows S&P earnings since the rally began in March 2003. Note the drops in the slope of successive trend support lines as the rate of earnings improvements decelerated then the final break as earnings began to weaken in early February 2008.

While stock traders began to party again after hearing news of the Fed March 12 credit bailout, currency traders were betting it wouldn't work. After staging a brief rally on Tuesday, the US dollar fell to a new all-time low against the euro Wednesday as confidence that the Fed move would solve the credit crisis and economic fallout proved short-lived.

Hopes have run high that the $250 bailout would prove the requisite panacea by stock investors prompting many to call a bottom in stocks. But here are five reasons why they will probably be disappointed.

It's hard to believe that it was just a little more than a year ago when the word "subprime" first became a cause for general investor concern and we were told by analysts not to worry. January 31, 2007 figures showed that GDP was growing at 4.4% and even though residential fixed investment had plummeted 19.2%, Global Insight chief economist Nariman Behravesh confidently claimed in the Wall Street Journal that "the soft landing is over, and I'm not even sure there was a landing."

Richard Moody of Mission Residential was even more confident. "For all of our worries about the housing market acting as a drag on consumer spending, there was no evidence of this during the fourth quarter," he said in the article.