Kristina Hooper, CFP®, CIMA® is Head of Investment and Client Strategies for Allianz Global Investors Distributors LLC. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
Gloomy profit forecasts and sluggish sales are eroding confidence in stocks.
Indeed, a weakening earnings picture extended the recent sell-off on Wall Street, despite encouraging comments from the Federal Reserve and news that GDP rose 2% in the third quarter. The Dow Jones Industrial Average and the S&P 500 finished the week in the red.
Headline company earnings disappointments seem to be taking their toll. Industrial giants DuPont and 3M were among the blue-chip companies that fell short of estimates. On the surface, earnings season is really not that bad. Consider that as of Oct. 26, 71% of the 245 companies that have reported earnings for the third quarter of 2012 have posted profits above the mean estimate. But drilling down, top-line revenue is concerning: only 36% of those companies have reported sales above the mean estimate. And even more troubling is the early guidance for the fourth quarter: 48 companies have issued negative earnings guidance while just 14 companies have issued positive earnings guidance.
Seemingly, there was nothing that could convince investors to stay upbeat on stocks last week. The Fed noted that we’ve seen moderate economic expansion and higher consumer spending, but these encouraging signs went overlooked. The Fed, not surprisingly, expressed concern over jobs: “Growth in employment has been slow, and the unemployment rate remains elevated.” The Fed said that it will continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. In addition, the Fed said it will continue its Operation Twist program to extend the average maturity of its holdings of Treasury securities through the end of the year. The Fed also reiterated that its policy actions should “put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.”
Investors should take comfort that the Fed remains extremely accommodative. It’s keeping the recovery from going off the rails. However, it’s important to recognize that continued central bank intervention takes us one step further down the road to financial repression.
Meanwhile, investors largely ignored third-quarter GDP growth, which rose 2%, well above the 1.3% growth in the second quarter. The growth spurt, which occurred in the face of flat business spending, can be attributed to several factors including an increase in consumer spending, which is in sync with the improvement in consumer sentiment that we have seen recently. The GDP results show a shift toward consumer and residential construction, away from structures, equipment and software investment as well as net exports. In particular, residential investment rose 14.4% in the third quarter, confirming the uptrend in housing starts. This suggests a consumer recovery is underway. Another big boost to GDP was government spending, particularly defense spending.
Perhaps GDP and the Fed’s statements weren’t able to counterbalance the earnings news because there is so much uncertainty right now. As we close in on Election Day, there are a number of close contests—not least of which is the presidential election. The outcome of these races will likely determine how the fiscal cliff is handled along with a host of policies including, it seems, leadership at the Fed. The market hates uncertainty, so stocks may continue to be volatile until the ballots are counted. Look for Friday’s employment report to be one of the key factors voters may consider in the final days before the election.
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