The earnings season is telling not just for the fundamental views of growth and sales, but also how it may weight on the Fed’s rate hike decision for the next two meetings. If the recent jobs report coming in far weaker than expected, combined with the disinflation (contracting inflation) should be reason enough that the Fed will remain accommodative and not raise rates, adding in weaker earnings forecast for the 4th quarter could just be the final nail in the rate hike coffin.
Earnings so far have been a mixed bag, but one common theme is the lower forecasts. Some forecasts have been lowered based on the dollar and world trade, others have been on contracting sales growth. When I analyze earnings, the most important factor remains the top-line sales and top-line revenue. Unfortunately, most are concerned with the bottom line and ignore the top-line story.
Why is top-line so important, because it is the ultimate track of revenue and sales. How much money did the company make before expenses? How was sales growth? Sure, the bottom line – after expenses and costs, which determine the profit, are certainly important. The problem with ONLY looking at the bottom line is that it can imply a distorted picture. Especially if the company is seeing lower revenue and lower sales, but improved bottom line. That means the company is making more profit, not by selling more, but rather by cutting costs. For me, I would always rather see top-line growth in sales and revenue, even if bottom line profits shrink, rather than the other way around.
The other huge factor that has fooled even the brightest financial advisors is the massive impact on share buy-backs, as it impacts the earnings. Earnings are reported as Earnings Per Share, shrink the outstanding shares (share buy-back) and it radically distorts the earnings, ironically for the better. In a recent Market Preview, I wrote about the “shrinking stock market” and how this impacts earnings. It is worth reviewing.
courtesy of wikipedia
IBM story is not looking good. Over a decade ago IBM made a huge shift from the technology business into the service business. They sold off their PC unit to Lenovo and turned their focus to technology services. Initially it was a brilliant move, the PC industry had become not only competitive, but also commoditized. The margins had been shrinking rapidly and the R&D costs to keep up with “Moore’s Law” only further eroded profitability.
The next decade seems strong and the company was positioned well, as it had an impressive customer base and could now sell-in new services. Of course like with any industry, competition arises and it only takes a decade (if not less) to see costs rise, prices decline, and margin squeezed. The big rivals like Oracle and Microsoft core business did not have too much overlap and smaller competition would be gobbled up in the growing M&A world.
Then we saw big data and cloud computing grab hold in the last few years. The concept of Software As A Service (SAAS) while not new, was now becoming the core business model for pushing new software. Other rivals quickly entered the space, Google, Amazon, Dell, Hewlett Packard, and others are now moving from their core businesses, whether it be selling goods, search engines, or building hardware – all now participating in Cloud Computing, Cloud Storage, and the SAAS model. IBM is getting blasted on all sides from competition, but worst – are getting quickly surpassed in services and technology. The other companies have been gobbling up new businesses to expand the Cloud and SAAS models, as IBM has been focusing from within.
IBM’s earnings were not great at all. Not only did they miss estimates, they also saw top-line revenue contract by 19%, the company does dispute that a big factor was the rise in the dollar and currency factors. However, that didn’t explain a drop of 10% in U.S. sales, while China’s sales fell 17% (note the Yuan is pegged to the dollar). The cloud computing sector of their business did see a 17% increase on a year-over-year basis, however it is still not the core revenue driver of the company.
The company message? Well they are in a transformation process. What they are really saying is they are playing catch-up, competition is tough, the dollar is a headwind, and they need to start jumping on the M&A bandwagon to expand their Cloud and SAAS models. Stock is down about 4% in the pre-market and a Dow Jones component, pulling down the index at the opening.
The hidden story for the Fed is how much is the strong dollar impacting company revenue and how much of the domestic sales drop is a factor of competition or economic slowdown.
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Amazon is certainly an interesting company. Most of us know it as that massive online shopping mall, but it has other services. Their Kindle e-reader business is the biggest in the world, their cloud storage and services are massive as well. The company is taking a page from Google’s playbook to expand beyond being a one-trick pony and becoming a technology conglomerate.
Amazon has announced it will be creating 100,000 seasonal (TEMPORARY) jobs for the holiday period. We need to be careful looking at job creation from October – November, because it can artificially look like there is a huge pick-up in the job market and imply the economy is improving. When the reality is the majority of job growth in 4th quarter comes from temporary jobs, that will be laid off after the holidays. The concern is that last month’s job creation at 146,000 came in drastically lower than expected and we should have started to see the start of holiday hiring in September. Interesting to see how big October picks up, we will not know until beginning of November.
Earnings are coming out this week and we should get idea of how the economy is doing based on the U.S.’s largest online retailer. Also will be looking for guidance for the holiday sales as well as how their cloud services business is doing.
Again, another one to watch as the Fed will certainly be paying attention mostly to the job story and holiday forecasts from this online retail behemoth.
The strong dollar is certainly a factor impacting earnings and also the prime factor creating disinflation pressure, including helping keeping a lid on gas/oil prices. Part of the Fed’s dual mandate is maintaining price stability and the Fed wants inflation, they have targeted 2 to 2.5%. The earnings are just confirming the strong dollar factor and disinflation, which I think plays heavy on the Fed as well.
Share Buy-backs, lower forecasts, weak job market, and certainly the strong dollar disinflationary environment – all being played out in the earnings story is just more confirmation the Fed will NOT be raising rates in October or December. In fact, I believe we will see talk of more accommodation and possibly hints of QE or something similar if this story continues.
Support & Resistance
We are pushing up into that resistance band of 17,200 – 17,400. We can certainly push up into 17,400, earnings are a drag right now. However, weak earnings mean we could be climbing that wall of worry. 17,200 seems to be holding for now, but could quickly turn into a straddle strike.
We are marching higher and even though some tech stocks have missed and we have seen some strong volatility, the broader market is fighting it and moving higher. We are certainly in a resistance band with 4500 the top of that area. So it could be struggle as we move higher.
Just like the Dow Jones we are marching higher and into that resistance band, meaning it will be a struggle. Getting to 2060 is certainly in the cards, but could be a fight to get there. Earnings are dogging the index right now.
The market has shrugged off the weak earnings, as it might be a good sign the Fed will not hike rates. I believe that we could get to the top of the resistance areas in a slow methodical way. However, the Russell is weak and not able to punch up above that 1180 area and that is showing me the general market order flow is not really buying into this rally, YET. The Russell has been in a bear market since July and we have not had any higher highs yet, getting above 1180 on some volume is key to prove that money is flowing back into the market as a whole. If the Russell has problems moving higher and revisits the 1140 area, then I think we could see selling pressure across the indices. Keep watching the Russell as the broad market trend.
Bad news is good news?
Earnings are a drag, but that could be a positive as it could reinforce an accommodative Fed and no rate hikes. That could send this market into rally mode again, as the ZIRP party is back on.
It is sad that bad news is good news, because ultimately we want the economy to stand strongly on its own feet and for the market to move on its own merits of fundamental strength or weakness, rather than relying on Fed interventionism. Unfortunately, I do not see an end to the Fed’s super easy monetary policies – not in the near-term or even the long-term.