Earnings – My Story

I have been reading quite a number of broking reports on second quarter earnings indicating that worst are over, as most reported earnings are beating analysts’ expectations by a margin. But a closer look at these numbers tends to suggest the alternative explanations than the headline numbers would suggest.

I believe this cloud of euphoria had more to do with extraordinarily low expectations than to any meaningful and lasting improvement in prospects. If one to bet this on stock market, I think the recent equity rally off the back of these results is overdone.

Also, there is a plenty of evidence to show that the exclusion in adjusted operating earnings and often this contain useful information that may suggest a possibility of weaker cash flows ahead.

A big thank should go to production and job cuts. There is no doubt that strong earning numbers in the last several years reflected extraordinarily high, debt-fueled margins that are difficult to imagine again in deflating and deleveraging economy. Sustainability earnings growth must entail some combination of increased profit margins, rising turnover or greater leverage. In current situation, increased leverage is unacceptable to managements and investors alike. Wider profit margins and higher turnover may be possible in short run, but are much less attainable in a deleveraging cycle.

I strongly believe that the most important ingredients for rising stock prices are not corporate earnings and global economic growth. Instead, the key elements are interest rates, inflation and sentiment along with help from government fiscal and tax policy. Historically, this is the environment in which stock prices have done their bests. As long as the recovery remains anemic with lackluster job growth, it remains the subject of tender mercy by policymakers desperate to placate an unhappy electorate. A full 65% of all companies are still in the process of slashing their headcounts. There is also the problem of the rising ranks of long-term unemployed as more job losses are permanent rather than temporary lay-offs.

The recent fall in China is a perfect example of this theory in action. The declines come amid new evidence of economic strength. Traders were spooked by Beijing’s efforts to tighten runaway loans growth.

If recovery is indeed drawn out, this is paradoxically great news. U-shaped recovery is exactly what investors should want to see.