Second-Quarter Corporate Earnings Are Revealing the Truth About the Market
In the first quarter of 2013, we saw an interesting and unexpected development. While the corporate earnings of S&P 500 companies were better than expected, their revenues weren’t nearly as impressive.
Just 46% of S&P 500 companies reported revenues above estimates. (Source: FactSet, May 31, 2013.) And the second-quarter corporate earnings might be similar—if not worse.
As we are just entering the earnings season, many S&P 500 companies have yet to report their corporate earnings, but some of the big household names have already started to strengthen my opinion.
Take The Coca-Cola Company (NYSE/KO), for example. The S&P 500 company not only reported a decline in corporate earnings, but also showed a decline in revenues. For the second quarter, Coca-Cola’s net revenues declined three percent from a year ago. Similarly, the company’s corporate earnings also dropped three percent, registering at $0.59 per share in the second quarter, compared to $0.61 in the same period a year ago. (Source: The Coca-Cola Company web site, July 16, 2013.)
In much the same vein, Mattel, Inc. (NYSE/MAT)—the world’s largest toy maker and constituent of the S&P 500—reported corporate earnings that were 25% lower than a year ago, noting that sales missed analysts’ expectations. Revenues registered at $1.17 billion, while analysts had been expecting $1.22 billion. Corporate earnings for Mattel declined to $0.21 per share from $0.28 per share year-over-year. (Source: Reuters, July 17, 2013.)
Another big name that’s reporting negatively is Yahoo! Inc. (NASDAQ/YHOO). This S&P 500 company reported corporate earnings that were above the consensus, but revenues witnessed a slight decline—$1.071 billion compared to $1.081 billion in the second quarter of 2012. In the near future, the company expects revenues to be lower than what it previously anticipated. (Source: Reuters, July 16, 2013.)
Keep in mind that before second-quarter earnings season began, we had 87 S&P 500 companies issue negative earnings guidance. The information technology and consumer discretionary sectors of the S&P 500 had the largest number of companies issuing negative guidance about their corporate earnings relative to their five-year average. (Source: FactSet, June 28, 2013.)
It’s odd that all these troubling developments in the corporate earnings of big-cap companies are going unnoticed in the mainstream media. What I see in the media are just stock advisors staying optimistic and not taking into consideration the reliability of corporate earnings.
Consider the Investors Intelligence Advisor Sentiment index. It has been increasing for three consecutive periods and is closing in on highs made in mid-May of 2012. (Source: Investors Intelligence, July 17, 2103.)
But I still see big-cap companies still trying their best to boost their corporate earnings through other means—call it financial engineering.
Take Yahoo!, for example. In the past few quarters, the S&P 500 company has purchased $3.65 billion worth of its own shares back, and in its first-quarter corporate earnings announcement, the company was very clear that it plans to purchase another $1.9 billion worth of its own shares back.
These anemic revenues mean that companies are not really selling more, and deteriorating earnings combined with key stocks heading higher continues to add more evidence to my belief that what should be a bear market is rallying by doing a masterful job at luring investors.
While it’s certainly not popular to be bearish in this market, the facts appear to be in my favor.
The Federal Reserve has made it very clear that it wants to stop quantitative easing. But it has also made it just as clear that it won’t begin to taper its quantitative easing program until certain conditions are met.
While speaking in front of the Committee on Financial Service, here’s what the chairman of the Federal Reserve, Ben Bernanke, said about ending quantitative easing: “I emphasize that, because our asset purchases depend on economic and financial developments, they are by no means on a preset course. On the one hand, if economic conditions were to improve faster than expected, and inflation appeared to be rising decisively back toward our objective, the pace of asset purchases could be reduced somewhat more quickly. On the other hand, if the outlook for employment were to become relatively less favorable, if inflation did not appear to be moving back toward 2 percent, or if financial conditions—which have tightened recently—were judged to be insufficiently accommodative to allow us to attain our mandated objectives, the current pace of purchases could be maintained for longer.” (Source: Board of Governors of the Federal Reserve System, July 17, 2013.)
But no matter when quantitative easing ends, one thing has become certain—it will have its victims. And the biggest victim of quantitative easing I see will be the bond market.
In its meeting in May, the Federal Reserve hinted that the quantitative easing will be slowing sometime later this year and ending completely next year. Since then, the bond market has seen selling. I have mentioned in these pages how the bond prices have declined and yields have soared higher.
The Investment Company Institute (ICI) reports that for the week ended July 2, 2013, the outflow from bonds mutual funds was $5.9 billion. (Source: Investment Company Council, July 10, 2013.)
And from the week ended June 5 until the week ended July 2, $66.65 billion was pulled from the bond mutual funds. If the bond mutual funds register a net outflow for June, then this would be the first net outflow since August of 2011.
What you need to realize is that the bond market is very big in size—much bigger than the stock market—and, if it declines, it could have a significant impact on the economy.
Consider this: if the bond market starts to see higher yields, then the mortgage rates will increase. We are already starting to see this. Just look at the chart below. It shows that companies that borrow to run their daily expenses will be paying more and in general, the cost of goods can increase.
Quantitative easing in the U.S. economy hasn’t done much for the economy, and it’s just a matter of time until things turn sour.
What we saw in the bond market since May is just a minor episode of what might happen when the Federal Reserve starts to taper its quantitative easing program.
To all bond investors: be careful—to enter the bond market now would be to tread in dangerous waters.