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Will Earnings Surprises Lift Markets?


Results surprised to the upside last week.

It's Earnings, Stupid! Or so it seemed during the past week as the stock market took its cue from a host of better-than-feared earnings reports, propelling the S&P 500 Index 4.3% higher – a bigger gain than for the entire 2007. And what a swift turnaround it was after the market got "GE'd" (General Electric (GE)) and was in sackcloth and ashes by the close of the previous week!

Thomson Financial estimated at the start of the week that first-quarter earnings would decline by 14.1%. However, when the financial sector is excluded, the growth rate for the remaining nine sectors would be 6.4%.

Against the backdrop of a US recession, this round of earnings reports is of particular interest for the stock market in order to ascertain specifically how the earnings for the non-financial sector stack up, i.e. whether more earnings announcements surprise on the downside than upside. (Earnings expectations for financials have already been reduced by so much that the potential for shocks is probably fairly limited.)

Mike Lenhoff (Brewin Dolphin) highlights the following: "... with nearly 20% of the S&P 500 having reported, the non-financial earners are doing comparatively well by surprising on the upside. For example, if one excludes the results for financials and consumer discretionary, we're talking about almost 5 companies surprising on the upside with their earnings for every one company surprising on the downside. The corresponding ratio for the entire set of companies that has reported so far is closer to 2."

It's quite apparent that the US currently has a two-stream economy, with multi-nationals such as Coca-Cola (KO), IBM (IBM) and Intel (INTC) being cushioned against the slowdown in the US by the weak US dollar and stronger growth abroad.

Let's briefly review the financial markets' movements on the basis of economic statistics and a performance round-up.


The Beige Book for the US was released last week and concluded that the economy was characterized as weakening over the past six weeks. "This downbeat report is consistent with our assessment that the economy is in recession," said Moody's

The past week witnessed a number of inflation reports causing concern about rising prices.

The Consumer Price Index (CPI) increased by 0.3% in March after holding steady in February. During the three months ended March, the CPI rose at an annual rate of 3.1% compared with a 4.1% gain in 2007.

Wholesale prices stoke concerns of hawks, with the Producer Price Index (PPI) for finished goods having risen at an annual rate of 10.2% in the first three months of 2008 versus an 11.5% increase in the fourth quarter of 2007 and a 6.3% gain in 2007.

Elsewhere in the world, higher fuel and food costs also saw price increases in Germany hit an annual rate of 3.2% in March. This helped drive inflation across the 15-country euro region to 3.5% last month – a 16-year high. Japanese inflation is also back, with consumer inflation now more than 1% for the first time this decade.

Back to the US, the Conference Board's Index of Leading Economic Indicators (LEI) declined by 1.8% in the first quarter of 2008. This is the largest quarterly drop in the current economic expansion. "Historically, negative year-to-year readings of LEI are associated with recessions," said Asha Bangalore (Northern Trust).

Furthermore, the housing starts and permits data in March suggested that the bottom for construction of new homes was not yet in sight.

Given the weakness in the housing sector, retail sales and employment conditions, the FOMC is most likely to lower the Fed funds rate by 25 basis points to 2.0% at its meeting of April 30. However, the upward pressure from rising import prices due to a weak dollar could result in the Fed deciding to adopt a wait-and-see approach after the April 30 meeting.

Economic Reports

Source: Yahoo Finance, April 18, 2008.

The next week's economic highlights, courtesy of Northern Trust, include the following:

1. Existing Sales (April 23): Sales of existing homes are predicted to have declined in March. Existing home sales have dropped 30.6% from their peak in September 2005. Sales of existing homes have fallen by 19.7% from a year ago in February. Consensus: 4.95 million versus 5.03 in February.

2. New Home Sales (April 24): Sales of new homes are expected to have fallen in March. Purchases of new homes have fallen by 57.5% from their peak in July 2005. Sales of new homes have declined by 30.6% from a year ago in February. Consensus: 580,000 versus 590,000 in January.

3. Durable Goods Orders (April 24): Durable goods orders (+0.5%) are predicted to reverse a part of the 1.1% decline seen in February. Consensus: 0.6% versus -1.1% in February.

4. Other reports: Consumer Sentiment Index (April 25).


The performance chart obtained from the Wall Street Journal Online shows how different global markets fared during the past week.

Source: Wall Street Journal Online, April 20, 2008.


Global stock markets experienced a strong week as the US earnings reporting season turned up better-than-feared results. The MSCI World Index gained 2.7% during the week, with both the US and European markets rising strongly.

The Asian markets experienced a mixed performance: The Japanese Nikkei 225 Average eked out a gain of 1.2%, but the Hong Kong Hang Seng Index and the Shanghai Stock Exchange Composite Index recorded losses of 1.9% and 11.4% respectively. The latter has now dropped by almost 50% since its peak in October 2007.

As far as the US stock markets were concerned, the strongest index was the Nasdaq Composite Index with a surge of 4.9% (its best week since August 2006), followed by the Russell 2000 Index (+4.8%), the S&P 500 Index (+4.3%) and the Dow Jones Industrial Index (+4.3%).

The energy sector (+7.7%), the technology sector (+6.3%) and the financial sector (+5.2%) were the star performers for the week.

Fixed-Interest Instruments

Monetary conditions for financial institutions tightened markedly as reflected by the three-month dollar Libor rate jumping from 2.71% to 2.91% during the week.

The rise in global stock markets and mounting inflation worries resulted in investors switching from government bonds to equities, pushing government bond yields sharply higher in most parts of the world. For example, the yield on the two-year US Treasury Note jumped by 43 basis points to 2.18%, whereas the 10-year US Treasury Note yield rose by 28 basis points to 3.75%. UK and other European bond yields showed similar increases. (Also see my recent article "Soaring inflation creates headwind for long bonds".)

US mortgage rates also increased, with the 15-year fixed rate rising by 22 basis points to 5.54% and the 5-year ARM rate increasing by 35 basis points to 5.73%.


The past week was characterized by a fair amount of volatility in the currency markets.

The US dollar hit an all-time low of $1.5983 against the euro before clawing back some of the losses to close 0.4% down over the week. The European Central Bank again stressed its concern about rising prices in the Eurozone, dashing hopes of an interest rate cut over the short term.

The Japanese yen was on the receiving end of investors' renewed appetite for risk and gave up 3% against the US dollar and 3.2% against the euro.


The Dow Jones-AIG Commodity Index notched up another gain (+2.4%) during the past week, with a number of commodities scaling fresh peaks.

West Texas Intermediate oil registered a record of $117 a barrel on Friday before dropping back a bit, but still closed 5.9% higher on the week. The surge was attributed to unexpectedly large declines in US crude and petrol stocks, supply concerns in Mexico and Nigeria and fears that Russian oil production had peaked.

Rice prices were subject to panic buying, hitting $1,000 a ton as concerns about supply shortages mounted on the back of major exporters imposing restrictions.

Elsewhere on the commodities front, copper reached an all-time high of $8,800 a ton as a result of a market deficit and a historically low stock-to-consumption ratio.

Source: Tom Toles, April 18, 2008.
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