Impact of credit market turmoil on Q3 earnings, US economy’s ability to stave off recession, oil price surge top concerns
IN NEW YORK
FROM the Fed and lower interest rates to corporate quarterly earnings, the stock market enjoyed a week of nearly unmitigated good news and outright euphoria that has temporarily but dramatically banished the demons of financial market collapses and hedge fund failures.
But now, as Wall Street’s analysts and traders trade in their obsession with the Fed and capital market liquidity – which started with the ‘will they or won’t they’ of late August, and evolved into the ‘how much will they’ cut interest rates debate of the past two weeks – to the market’s other two fundamental market drivers – economic growth and corporate profitability – investors must wonder if the two weeks’ worth of strong rallying on Wall Street will fade just as quickly as the euphoria.
Looking at the bullishness which has sent the Dow Jones Industrials rocketing forward by more than 5 per cent in just 10 days of trading, Joe Battipaglia, stock market strategist at Ryan, Beck, thinks stocks may be due for a pause this week as the investing community stops to assess whether the gains share prices have achieved lately are justified by market fundamentals.
‘The incredible sense of relief over what appears to be the containment of the credit market crisis and the Fed’s strong response to liquidity issues is probably going to shift to a more sober assessment of where we stand now,’ he said.
And that assessment must include how hard the summer’s credit market turmoil has hit third quarter corporate earnings, the US economy’s ability to stave off recession, and the recent surge in oil prices to yet another record high level which could provoke inflation as well as threaten to dampen consumer spending.
Still, investors’ euphoria over the Federal Reserve’s fifty basis point cut is based on the sound logic that stocks historically tend to perform better when interest rates are falling.
At week’s end, analysts found other reasons to hope that the Fed-inspired bull rally of the past two weeks has more legs, with good news from software developer Oracle, which posted a fiscal first-quarter profit that rose 26 per cent from a year ago, and Nike, which also handily beat fiscal first-quarter earnings and revenue targets.
Goldman Sachs, Morgan Stanley, Lehman Brothers, and Bear Stearns all posted quarterly profits, giving investors assurance that the credit crisis won’t derail corporate earnings.
On Friday, the Dow Jones Industrial Average gained 53.49 points, or 0.39 per cent, to 13,820.19. The S&P 500 was up 7 points, or 0.46 per cent, to 1,525.75. The Nasdaq Composite was better by 16.93 points, or 0.64 per cent, to 2,671.22. It was the second winning week in a row. The Dow and the S&P 500 both climbed 2.8 per cent for the week, and the Nasdaq added 2.7 per cent.
‘I think (Friday’s) strong market performance is an indication that investors are feeling optimistic about the third and fourth quarters for corporate earnings,’ said Hugh Johnson, chief investment strategist at Johnson Illington Advisors.
‘There’s still a lot of worry about the fallout on corporate America from the subprime mortgage contagion, and seeing these good early results gives a boost as we head into earnings pre-announcement season,’ he said.
Currently, the estimated growth rate for the third quarter stands at 4.1 per cent, according to corporate earnings tracker Thomson First Call. On July 1, the estimated growth rate for the Q3 07 was 6.2 per cent.
In the S&P 500 index, there have been 51 negative pre-announcements issued by corporations for the coming quarter, and 26 positive pre-announcements, pretty much the historical average for the S&P 500. But earnings aside, most analysts believe the market will continue to move according to the betting on future Fed action.
‘Over the next few weeks, Wall Street will be parsing the economic data not just to get a sense of the economy’s health, but more so in order to figure out whether the Fed is going to give us another rate cut at its October meeting,’ said Mr Johnson.
This week, Wall Street will have ample opportunity to play the economic guessing game, with several key readings on the economy from new and existing home sales numbers today and tomorrow, respectively, followed on Wednesday by durable goods orders. Consumer confidence poll is due tomorrow and University of Michigan consumer sentiment for September is due on Friday. Final second quarter GDP is to be released on Thursday, and personal income and construction spending on Friday.
Investors will be in the uncomfortable position of hoping for economic data that’s not bad enough that it shows the economy heading for a recession, but weak enough that the Fed feels it necessary to cut rates further to prevent a recession.
‘That’s one reason I think we can expect to see plenty more volatility over the next month or two,’ said Mr Battipaglia. ‘We have a lot of issues yet to be decided, and until we get some more clarity on the economy, we’ll get some big swings,’ he predicted.
Source: Business Times 24 Sept 07
