January 1st and 2nd saw sharp gains in the Dow Jones Industrial Average (.DJI) as investors looked for a protracted U.S. recovery and generally positive macroeconomic trends. Those positive indicators have come throughout January; last week, jobless claims fell to their lowest level since January 2008–or since before the subprime crisis crippled the American economy. Housing starts were up in December, again at their highest level since the crisis hit–this time, home starts reached levels of July 2008.
Yet on the days that these announcements were made, indices rose modestly. The S&P 500 remains well above the 1400 level, hovering between 1470 and 1480 throughout last week. The Nasdaq 100 is even down slightly for the week, although still bouncing above the 2725 resistance level. Despite its sharp gains on the first days of 2013, the DJI has stayed more or less flat for the rest of the month. While still on an upward trajectory, the growth curve is not as steep as in early 2012.
The Problem with Earnings
The biggest drag on equities is low earnings, which is partly the result of sluggish consumer demand. Despite an improving economy, the improvement is slow and wages are still stagnant while unemployment remains very high, even if slightly less than it’s been in recent memory. These trends are impacting firms all sectors.
Take Texas Instruments (TXI), which surprised the street with lower than expected sales of concrete and building materials–a worrying forward-looking indicator that hopes of the housing market’s recovery might be over-exaggerated. The homebuilding ETF (XHB) is still up an impressive 5.7% YTD and over 47% over the past year, but TXI’s disappointing earnings should be a sign to analysts that they need to do their homework to ensure that the risk/reward profile of this sector has not changed substantially.
Another complex sector that both is and is not showing signs of health is financials. Citigroup ( C) disappointed investors with below-expectation earnings, yet another blow for the company that indulged in a reverse split in recent memory after seeing its book value slashed significantly. The company’s troubles have hurt the firm so much that its CEO surprised investors by suddenly resigning a few months ago. But even more promising financial firms are failing to impress. Wells Fargo (WFC) beat estimates with EPS of 91 cents, a 24% year-over-year increase. However, a sluggish top-line is a signal to more long-term worries than a surprise beat would suggest. Bank of America (BAC) also disappointed, as EPS of 3 cents fell below expectations due in large part to one-time charges related to the messy mortgage holdings the bank inherited from its takeover of Countrywide, perhaps one of the worst takeover decisions in human history. Bulls say that this is a hangover from a disastrous past, and that the worst is over. But bears would point to Bank of America’s constant restructuring (14,601 Bank of America employees lost their jobs in 2012) as sign that the company will lack the might to outperform previous quarters.
Then there’s American Express (AXP), whose fourth-quarter net income fell by an astounding 47%, causing the stock to plummet by nearly 3%. However, a modest 5% increase in revenue suggests greater consumer spending–at least on Amex cards–and could offset the concerns for American Express, which have a lot to do with the firm’s internal problems (it lost $600 million due to restructuring costs and saw its expenses rise due to new product offerings). However, Capital One’s disappointing earnings (COF) resulting from slackening demand easily counters the tiny silver lining afforded by AXP’s revenue growth.
As for technology, once the darling of growth-oriented investors, things have not been good for a while. The biggest tech-oriented ETF (XLK), has stayed relatively low for the past 6 months and has not offered the short-term appreciation that it has in the past. Partly, this is because its largest holding–Google (GOOG)–is dragging the fund down. The company’s revenue stream is being hit by less advertising income and a shift to mobile devices. The other tech darling stock, Apple (AAPL), has simply become a dog. Down over 6% since the New Year and over 20% in the past 3 months, several pundits are already pontificating that the days of an Apple-led U.S. recovery are history. Competition from Samsung, Android, and other alternatives in the tech market are making the company’s exponential growth figures seem impossible going forward. Meanwhile, Intel (INTC) is becoming perhaps the biggest disappointment for investors, with a 27% drop in profits on a year-over-year basis causing the shares to drop by over 6.5%. The disappointment is hitting several indices, since the firm has become a dividend-yielding blue-chip large-cap as well as a cutting-edge tech company.
How to Respond
Looking at all of this, any investor would be wise to admit his or her confusion. The marketplace is always complicated, but since 2008, things have frankly been weird. And while they’re arguably less weird than 2010 when company cash reserves were soaring alongside food stamp applications, there is still a large disconnect between what is happening in individual companies and in the macroeconomic environment. Except now the trend lines are changing.
While demand for homes is growing and applications for unemployment benefits are declining, consumers would naturally be expected to spend more and be confident enough to raise demand, in aggregate, for the services that companies offer, including all of those listed above.
The problem is the time gap. We are now seeing the results of the last quarter, when fiscal cliff fears, disruptive technologies, anemic job growth, and a presidential election all fundamentally changed the makeup of the economy.
Any investor needs to cleave these extraneous factors from his or her model of what is going to happen going forward.
For bulls, there is a sense that a lot of the bad news that is dragging down large-cap earnings is a temporary and historical problem. BAC’s Countrywide takeover is 5 years old. The shift to mobile devices and Android’s creeping market share are 2011 headlines. The one big forward-looking concern is the disappointment from TXI, which should be cross-referenced with other building materials companies.
A smart investor will now look at each of these trends carefully to determine which are the result of hangovers (BAC, C, WFC, AAPL), and which are signs of serious macroeconomic threats (TXI, AXP, COF). Then, with this distinction in mind, the investor should adjust upside and downside scenarios in their models and invest accordingly.