Everything's Coming Up Roses, So What's With All the Thorns?
5/13/2005 12:24 PM ET
A number of articles have come across the newswires of late touting the pleasant surprises 2005 has brought us so far. Merger Mania! Elevated Earnings! Distinguished Dividends! The nation's press (and many of the country's leading stock-market analysts) continue to sing a tune reminiscent of Ren and Stimpy's "Happy happy joy joy!" While I can't disagree with the cut-and-dried facts of positive earnings surprises, boosted buyback activity, and other signs of fundamental health, what I do take issue with is thereaction to all of this "excitement." If everything is truly so great, where is the rally? Here's a list of a handful of excuses the market has had to spark a market surge. And so far, equities have failed to capitalize on a single one of them.
Corporate Profits
Roughly 90 percent of all S&P 500 Index companies have issued their second quarterly earnings report for the year. On average, earnings have grown by 14 percent on a year-over-year basis, according to First Call. This is almost double the 7.6-percent growth rate analysts were expecting as 2005 dawned, and notably higher than the 8.2-percent growth prediction reported in early April . Leading the charge is the materials sector, with year-over-year earnings growth of 64 percent. Other strong sectors included energy and industrials, but nine of 10 S&P sectors are positive in terms of earnings growth, and seven of these sectors are enjoying double-digit earnings increases. Only consumer discretionary issues suffered an earnings pullback this past quarter. But positive surprises have been greeted with apathy, or with healthy but all-too-brief rallies.
Merger-and-Acquisition Activity
In the first four months of 2005, U.S. companies announced a total of 2,600 takeovers and mergers, deals which together enjoy a total value of $340 billion. And there are some pretty big players involved in some of these deals. Procter & Gamble and Gilette. Cinergy and Duke Energy. Federated Department Stores and May Department Stores. ChevronTexaco and Unocal. And perhaps you've heard of Verizon Communications' desire to purchase MCI? M&A activity this year is on track to match 2004 levels of $822 billion. This should be a cause for excitement! An outpouring of support into the relevant stocks and the market as a whole! So far ... no dice.
Dividend Boosts and Buybacks
Heading into 2005, one of analysts' biggest bullish arguments was that corporate balance sheets were sodden with cash, suggesting economic health and fundamental solvency. Strong balance sheets are a factor that should lure additional cash into the market, but this hasn't exactly been working this year. The market only rises if there is more buying occurring than there is selling. And so far this year, it's been a sellers' market.
During the first one-third of the year, more than a quarter of S&P 500 companies boosted their dividend payouts. Specifically, 141 of the 500 firms had increased their payout, compared to 110 making a similar adjustment in all of 2004, according to Standard & Poor's. Additionally, a half-dozen SPX firms have already introduced a brand-new dividend payment. In 2004, only five companies made this commitment during the entire year. While increased dividends are a positive, the reactions will be muted when this isexpected versus instances where dividend increases come as unexpected. In other words, cash flowed into many stocks late last year when news of the cash-rich balance sheets hit the press. As such, there was little cash left on the sidelines to juice stocks on these announcements.
In another sign of corporate health, 186 companies have already set buyback programs into motion this year, collectively worth $90 billion. This is double the total amount of all S&P 500 buybacks announced in 2004 by the same point in the year. It's a good thing the companies are repurchasing their own shares, because buyers seem to be few and far between.
Long-Term Interest Rate Reduction
The yield curve (between the two-year and 10-year T-bills) continues flatten and recently hit a four-year low. Many have perceived declining long-term rates as bullish, while ignoring the fact that a stagnant yield curve suggests stagnant growth. With long-term yields in decline mode, consumers have been able to refinance their debt which could, in theory, free up cash for shorter-term, more aggressive investment opportunities. But where has all the extra money been going to? Not into the stock market. And not into the nation's shopping malls, as retail sales have struggled for the past few months. Possibly toward the costs of maintaining a heated home and a vehicle?
Additionally, the market supporters, perhaps legally blinded by now thanks to the harsh tint of their rose-colored glasses, continue to try to have it both ways. The aforementioned signs are cause for celebration and continued optimistic pandering, while any negative signs (slowing economic growth, increased inflationary pressures, rising oil costs) are dismissed as "normal" or chalked up as a "soft patch." What? Us worry? Well, how come no one is worrying about the equity market itself?
We're nearly five months in to 2005, and the chatter remains upbeat, with these fundamental facts consistently harkened back to as optimistic talking points. Not only are the market's year-to-date returns not seen as a legitimate cause for concern, but the fact that things are, historically, prepared to turn even worse (Does "Sell in May and go away" ring a bell?), has been largely ignored. A recent survey of fund managers revealed that more than half are "overweight" in equities, the highest such reading in six years. Denial isn't just a river in Egypt, and even the most optimistic of bulls will eventually be smacked with a nasty dose of reality. Who knows who long it will take for this to sink in, but when it does, I envision bouts of selling that could be quite detrimental over the near term, possibly knocking as much as 20-percent off the Dow by year's end.
-Bernie Schaeffer
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