Sunday, July 26, 2009

The Market Is Up ... For Now

Surprisingly, the market was unchanged on Friday despite major misses by Microsoft and Amazon.  With the market showing some resiliency despite disappointing earnings from these bell-weather stocks, one has to believe that the market is indeed up from here.

But it quite honestly does not make any sense.  We are not in for any type of recovery any time soon.  I think a lot of people are looking at the housing bubble popping like the tech bubble popping.  People believe that recovery is just around the corner and that companies' earnings will follow.  I just really don't see that happening.

One just has to look deeper into the numbers to see what is happening.  Most companies are beating expectations because of the bottom line, not the top line.  That is, their revenues are not that strong.  They manage to meet earnings because they have controlled their costs effectively.  This should be a good sign because it will allow companies to use operating leverage if the economy recovers.  Sales will grow faster than the cost structure meaning that companies will be very profitable on their way out.

But this assumes the economy is going to recover soon.  Look at what happened last time.  We came out of the problems we had by creating another asset bubble.  Housing.  By keeping interest rates low and allowing questionable lending practices, the government was  able to paper over the previous problems with brand new problems.  Of course, it took a few years to play out but like all deferred problems, the new ones were much much worse.  Further, the jobs that disappeared with the tech bust never really came back, they just reallocated.  We had a "jobless" recovery last time.  Many of the high paying tech jobs never came back.  Some were replaced by good paying real estate jobs but by all accounts more good jobs were lost than were made.

That is not going to happen here.  I just do not see us able to paper over the problems that we have now created.  They are too big.  The housing bubble will not be re-inflated so what will take its place?  Health care? Another tech bubble?  I honestly don't see anything even remotely resembling a recovery back to where we were. Companies are being very cautious when it comes to raising their cost.  For most companies, the biggest single cost is headcount and most will not be willing to increase this anytime soon.  Flat is the new up and I think more than a few companies will be willing to forgo higher revenues for a more predictable and low cost structure.

So we will see a long period of cautious companies.  Risk taking will be dampened.  This will mean that we will have an extended period of high unemployment.  This should have the effect of keeping any sort of earnings growth muted because most companies have cut to the bone at this point and will not see any more gains achieved from there.

How much more can it go from here?  Like all other market movements, I have no idea.  The market can stay stupid far longer than anyone can anticipate.

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