Recovery Goes Global, Unevenly (Pundit Watch)
Domestic economic data offered a glimmer of optimism for pundits charting the U.S. recovery, and developments overseas were also encouraging. These turnaround stories – the one at home and the one abroad – remain connected, but their plotlines are getting more complicated.
In the U.S., investors want to see if third-quarter earnings yield genuine revenue growth or profits based on weak comparisons and down-to-the-bone cost cuts. The global recovery complicated matters last Tuesday when the Reserve Bank of Australia raised interest rates to 3.25%, up from a 50-year low of 3%. The rate hike signaled that the recovery is moving faster elsewhere and impacting U.S. markets as it does.
“Given the news of the surprise interest rate hike by Australia’s central bank and the strength of the morning futures, the rally only managed to last about 100 minutes into the trading session,” Concept Capital technical analyst John Kolovos wrote Wednesday. That’s because U.S. investors now fear a similar move by the Federal Reserve in a potentially fragile phase of our own recovery.
Merrill Lynch global strategist Michael Hartnett wrote Tuesday that there’s a more important lesson to be gleaned from Australia by looking at the nation’s rising house prices, booming stocks and the government’s role in the nation’s recovery.
“Australia ‘09 equals a textbook study of asset price reflation successfully boosting economic activity,” he said. “Policy has driven asset price recovery in 2009.”
It short, stimulus worked there. As Australia’s economy picks up, it supports the August increase in the Organization for Economic Cooperation and Development’s (OECD) composite leading indicators, which, ISI Group chief economist Ed Hyman said Friday, signals an “unprecedented synchronized global upturn.”
But, but, the bears sputter, the United States has a 9.8% unemployment rate, and that’s not pushing recovery.
As Hyman said in a Thursday dissection of jobs data, “employment outside the U.S. has already increased [in Australia,] the equivalent of roughly one million [jobs] increases the odds that U.S. employment increases,” he wrote.
“First, foreign employment creates demand for U.S. employment. Second, the same forces lifting employment abroad are also at work here. Employment is the key to sustainability of the recession.”
And that’s why this earnings season – and a hands-off approach to interest rates by the Fed — remain critical.
“So it all boils down to earnings. Can they recover even if employment remains weak?,” asks economist Ed Yardeni of Yardeni Research in an Oct. 5 note. He says yes. “U.S. companies are scrambling to decouple from the U.S. economy, and are finding more revenues and earnings overseas, especially among emerging economies. Furthermore, even a subpar recovery in domestic revenues could morph into significant earnings growth given all the cost cutting that has been going on during the recession.”
But earnings alone won’t support a recovery. LPL Financial chief strategist Jeffrey Kleintop said Oct. 5 that investors are looking for more than profit wrung from cost cuts and reduced inventories.
“We expect stocks may rally as third quarter results are reported, and will be tracking the pace of revenue growth from the second quarter, he wrote. “Last quarter, [gross domestic product] was negative with little revenue growth to go around and the earnings results were boosted in large part by cost cutting. But in the third quarter GDP is likely to have been positive, and we expect to see better top-line growth helping to drive results.”
When that happens, it should juice individual stocks, said John Schonberg, manager of the RiverSource Mid Cap growth fund (INVPX).
“Because corporate America remains exceptionally lean, companies that beat top-line estimates even slightly will achieve favorable bottom-line results,” he said Tuesday.
Investors expect a lot from this earnings season, but those results have to be substantial, Citigroup chief U.S. equity strategist Tobias Levkovich wrote Oct. 5.
“There is a clear sense of optimism around the coming quarterly earnings release period, with many investors expecting better-than-consensus forecast results,” he said. “As opposed to late June/early July when expectations were muted and an upside surprise could boost share prices, the hurdle rate appears much higher now and companies may need to dramatically exceed analysts’ estimates to generate further market gains. The ‘beats’ also may need to include some top line improvement and not just cost cutting since investors want EPS recovery sustainability.”
Smart and anxious investors look ahead for threats to recovery, and in addition to concerns about revenue growth and GDP pickup, they are scrutinizing every utterance of the Federal Reserve Board regarding a possible interest rate hike, even though such a move is likely months away.
Fed watchers are tea-leaf readers, but ISI Goup analysts Andy Laperriere and Tom Gallagher saw something important in Chairman Ben Bernanke’s Thursday speech, when he used the phrase “accommodative policies,” to address the rate issue. That replaced “exceptionally low levels of the federal funds rate,” an earlier wording that had been interpreted to mean a long period of low rates.
Although a small tweak in language is a far cry from the Reserve Bank of Australia’s about-face, “wording changes like this more often than not convey some change in thinking,” Laperriere and Gallagher wrote. “This would represent a more ambiguous commitment on the starting point for rate hikes, giving the Fed more flexibility. It doesn’t necessarily mean an earlier start to hiking rates.”
It does mean that the complex global economic puzzle is being worked out slowly, one word — and one nation — at a time.
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