Surviving Corporate Earnings Reports... thus far

April 23, 2009 Edition, Volume III

Inside Signature Update
- The Dow and S&P500 Survive Corporate Earnings Reports – thus far
- Pressure from the Treasury and Federal Reserve?
- The Next Chapter in Detroit’s Woes
- Energy Policy Concerns


The Dow and S&P500 Survive Corporate Earnings Reports – thus far

The US equities market has maintained much of the strength it gained during the March and early April rally in spite of low 1st Quarter earnings reports. Currently, the DOW hovers just under the 8,000 point mark, while the S&P flirts with 850. Though both of these levels are simply shadows of the late 2007 highs for both indexes, they are important in that they reflect the market’s expectations for the US economy in the 3rd and 4th Quarters of this year.

There have been pockets of volatility in the last week or two, most notably the banking sector, but the broader market has successfully fought off downward pressure and has held solid. Many analysts had expected a market retrenchment towards 7,000 on the DOW and 750 on the S&P as earnings reports were released, but to date the trend has been more one of stability than not. While there are still those calling for further weakness in banking, which could weaken the markets as a whole, there is mounting evidence that banks and other financials have found pathways to profitability as interest rates remain at record lows and the increase in unemployment has slowed dramatically.

March’s lower than expected retail sales figures are expected to be overcome by gains in April as consumers opened their wallets for Easter. Retail and manufacturing inventories remain low and are setting the stage for improved labor markets at the point that banks begin to release credit capital into the markets, thus allowing employers to hire with relatively low-cost funding. The current increase in mortgage refinancing, with residential interest rates lower than at anytime in recent memory, combined with a net savings rate approaching healthy levels, may set the stage for consumer spending to increase sufficiently to make a meaningful difference in the labor markets, with or without capitulation from the capital markets.

With low inventory levels, increases in spending will force employers to find a way to put employees back to work to keep up with demand and to replenish inventories. The sagging US auto industry is banking on this in spite of plans to shut down certain manufacturing plants for up to nine weeks this summer.

What continues to provide widespread frustration and risks turning the markets to the negative is the federal government’s continued involvement in the banking and automotive sectors. Though it may be reasonable to expect the current administration and legislature to exert influence in the face of having pumped billions into these industries, it is just as reasonable to expect that shareholders and executives are concerned and may be holding off on executing important operating plans until they see just how involved the government may become in their businesses.

Unwittingly, federal policy makers are creating some of the problems over which they appear to be most concerned; specifically bank lending levels. As banks are lining up to repay TARP resources, a move expected to decrease federal involvement, they risk decreasing capital available for lending as well; they are clearly signaling that this would be preferable to unwelcomed federal intervention. As profitability among major banks has increased dramatically in recent months, owing to lending inexpensive funds at relatively high interest rates, many banks are willing to forgo possible profits in exchange for decreased government involvement in their board rooms and management structures. Some have suggested that these banks may actually prefer having to deal with toxic assets rather than a toxic government.


Pressure from the Treasury and Federal Reserve?

New York Attorney General Andrew Cuomo’s announcement early Thursday that then Treasury Secretary Hank Paulson exerted significant pressure on Bank of America CEO Ken Lewis in order to get Lewis’s agreement to acquire Merrill Lynch may add details to what was an unexpected pairing of financial giants, but comes as a surprise to virtually no one. Most familiar with the extraordinary differences in the corporate cultures, balance sheets, and operating systems of the two companies have been certain that the marriage came at the end of a shotgun. What is interesting though, and should give pause to many, is how desperate the Federal Reserve and Treasury were to get this deal done rapidly. The mounting systemic risk to the financial system at the time would almost certainly have spelled disaster had Paulson and Bernanke not acted as they did. We may never know just how close we were to an outright depression had it not been for the determination of these leaders and their senior staffs.

Interestingly, the actions taken by the Federal Reserve and US Treasury in the interim read as a play-by-play recitation of Bernanke and Council of Economic Advisors Chairperson Christina Romer’s conclusions on how the US might have avoided the 1930’s depression. It should be comforting to know that policy makers actually have a plan from which they’re operating; many have suspected just the opposite.


The Next Chapter in Detroit’s Woes

General Motors announcement earlier this week that it will likely miss a one billion dollar debt payment to bondholders on June 1st sets a timeline for the company to either file bankruptcy or allow for possible nationalization. Thank goodness – allowing the situation to drag on only hampers the company’s ability to get beyond their problems, weakens the markets, and further erodes consumer confidence.

Amazingly, GM shares continue to trade, albeit at depressed values. This in the face of continued announcements that GM is preparing for bankruptcy (in which case shareholder value is wiped out) or conversion of federal loans into equity shares (in which case current shareholder value is diluted to a point of triviality).

Chrysler is reportedly making plans for a bankruptcy filing as early as May 1st and has obtained the approval of the UAW (United Auto Workers), one of the last remaining stumbling blocks in a move to save the company, if not shareholder value. Chrysler is privately held by Cerberus Capital and has become an afterthought in the capital markets.

Ford Motor Company, which may become the last remaining US automotive manufacturing stronghold, is gearing up to take advantage of the continued weakening of its domestic competition. Though the company has problems of its own, the current situation appears to have revealed Ford’s relative strength among weakened competitors. While all three brands may survive, it is certain that Detroit has lost its economic muscle at a time when the US economy needs all of the manufacturing jobs we can get.

All of this is interesting, but may mean little as the impact of additional auto manufacturing layoffs may have already been worked into the markets as the investment value of the auto manufacturer’s debt and equity shares has been discounted to a point where it is almost irrelevant in the global markets. This only leaves the impact to the consumer, which appears to be less of an issue every day as the company’s products are in some cases growing increasingly difficult to distinguish one from another; aside from the Corvette of course! The brightest stars still held by Detroit’s big three are also the most maligned by an energy sensitive marketplace: American muscle, SUV’s and the light-truck market.


Energy Policy Concerns

Last summer, as oil prices reached record high’s, consumers, public policy makers, and the markets clamored for efficient energy development across all ranges of the natural resources markets. Predictably, officials proclaimed the need to reduce the nation’s dependence on foreign oil just as they have in virtually every decade since the 1950’s. But just as predictably, as the price of oil declined below $40 per barrel and has now settled into an intermediate range of $45 - $55, the clamor has become more of a murmur and the stage is being set for another national energy crisis. At the very time that the Obama administration should be aggressively seeking alternative sources for clean, renewable energy they are slowly curtailing the range of possibilities.

According to administration officials and the President himself, oil and gas drilling and exploration, and nuclear energy development are once again virtually off limits, while energy demands continue to climb. The administration is supporting ‘cap and trade’ policies – ripe for fraud and abuse - in an effort to reduce carbon emissions and ignoring the ‘tax’ such policies will have on the consumer. Some estimates place the cost of meeting increasingly aggressive emissions standards at as much as $4,000 per taxpayer per year, not to mention the ‘taxing’ effect higher energy prices have on the economy. So much for middle class tax breaks!

With relatively low energy prices, and in the midst of a national financial overhaul, the administration has the near-perfect opportunity to open up efficient exploration, bring back the utility of proven, technologically sound, and clean nuclear energy production, and at the same time create what some energy industry experts expect to be as much as 300,000 jobs.

What on earth are we waiting for… another energy crisis?



Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management and CEO of Signature Management, LLC