Warnings Stifle Stocks
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Obviously, something’s wrong somewhere as it relates to the economy and the concurrent performance of the stock market.
The economy, though growing, is also slowing. A rash of weaker than expected second-quarter earnings numbers from corporate America is unmistakably indicative of this trend. Further evidence is cutbacks in estimated GDP. For example, Standard & Poor’s recently chopped this quarter’s projected GDP growth from 4.7% to 3.4%
A worried stock market is already reacting. In recent weeks, for example, speculation has been widespread on Wall Street that a Bush stock market bounce was imminent, spurred by the president’s improving poll numbers and the absence of a widely feared terrorist attack in America during the Republican National Convention.
Granted, the market did spurt about 5% between August 12 (when the Dow hit a low of 9,814) and early this month. But now, with the Dow at 10,313, the advance has pretty much petered out.
One widely respected investment strategist who had predicted a Bush bounce, Fred Dickson of D.A. Davidson & Co., of Great Falls, Mont., now seems to be having second thoughts. His rationale: the emergence of an immediate new market danger stemming from increasing economic weakness, or more specifically, the surge in earnings warnings – a 70% jump from 223 in the past quarter to 380 in the current quarter, which still has several weeks to go.
The latest culprits are aluminum giant Alcoa and restaurant chain Ruby Tuesday, whose shares, in reaction to negative warning alerts late last week, fell Friday 7.6% and 5.1%, respectively.
Their bum tidings came on the heels of an Intel warning a week earlier, which cast a pall over the entire technology sector. It’s also raising an obvious question: Who’s next?
Earnings warnings, which numbered 447 in the first quarter of 2003, are a lot higher this quarter than most pros expected. “I’m surprised at the number of companies turning cautious and saying things are weaker than expected,” Mr. Dickson said. Though these numbers are relatively small in the context of more than 6,000 public companies, still, they’re growing and reaching the radar screens of traders, which is frightening, he added.
Why so? Because, he explains, it raises questions about the vigor of the fourth quarter and the first quarter of 2005, which could cause business to cut back on 2005 spending plans and prompt analysts to shave their earnings estimates.
As a result, Mr. Dickson said it’s understandable that many institutional investors are reluctant to make commitments at this time. “You don’t want to get in front of a freight train, which is what more and more earnings warnings are all about,” he observed. Noting that the economy began slowing down in May and June, he said the pivotal question now is whether the earnings warnings are merely a speed bump or something more serious.
He opts for the former, based on his belief that we should see a resumption of normal 3%-4% GDP growth in 2005 and 2006 as a result of tremendous liquidity in the system, record amounts of corporate cash flow and personal income, and low unemployment (5.4%). Such an economic showing, he said, is equivalent to annual 7%-10% profit growth over the next two years, which, he believes, should keep the bull market alive.
By the same token, Mr. Dickson is not oblivious to the risk factors. Chief among them, he said, is an increase in short-term earnings warnings, domestic terror threats, a rise in oil to $50 a barrel (currently $44.60), renewed weakness in capital spending, and the lack of a rebound in consumer spending.
Between now through the end of October, Mr. Dickson figures the Dow, negatively impacted by the slew of earnings warnings, will trade in a 10,000-10,500 range. After that, he sees a rising trend, with the Dow wrapping up the year at around 11,000.
What about the election? It’s unimportant as a market influence, observed Mr. Dickson, who once told me a Kerry win could spur a 7%-10% decline in stock prices. Why the change? Because a Kerry win, he said, would no longer come as a shock and is already factored into current stock prices.
Meanwhile, you have to wonder, given the failure of the Bush bounce, if Mr. Dickson’s enthusiasm for the market will live up to his expectations if there’s no letup in both the accelerating rate of earnings warnings and negative corporate guidance, as well as stepped-up cutbacks in estimated GDP growth.