, On Tuesday June 22, 2010, 3:57 pm
EDT
As the captain of a large
vessel navigates through high seas, he spots a light on a collision course.
'Change your course 10 degrees East' he signals. 'You change your course 10
degrees West' he gets in return. His reply: 'I am a Navy officer, so you
change your course' is met by 'I am a seaman of second degree, you change your
course'.
The captain is furious and
sends his final warning, 'I am a battleship and won't change my course'. Is
there any reply that would change the captain's mind? The final signal received
is: 'I am a light house, your call'.
New Highs or Bear
Market Trap?
Lighthouses can save lives;
however, if you steer right towards them, you are likely to sink.
Rising stock prices can
improve investors' financial lives, but some rallies are bear traps that can
and will sink your portfolio. The last nine trading sessions have lifted the
S&P 500 (SNP: ^GSPC) 5.18%. The Dow Jones (DJI: ^DJI) and Nasdaq (Nasdaq:
^IXIC) have faired the same. Is this the first leg of a rally that will lead to
new highs or a bear market trap?
Just as the lighthouse, the
market won't change course for us. Therefore, if we can't bend the stock market
(NYSEArca: VTI) to our will (no matter how bad we want to), we have to
figure out what the market has in store for us.
The market and many
individual stocks have an uncanny ability to look ahead and foresee problems we
can only dream of detecting. While we are still wondering whether certain
issues (I.e. European debt crisis, U.S. debt crisis, BP oil spill, etc,) have
already been discounted or 'baked in,' the market has already discovered the
next problem area or green shoot.
Subtle Tell Tale Signs
Even though it's difficult,
we'll do our best to discover what Wall Street's radar has not yet picked up.
FedEx (NYSE: FDX
- News)
is one of the many companies to lower its profit outlook for the year ahead. As
such, FedEx might well be the canary in the mine. Why? FedEx ships 'stuff,' all
kinds of stuff. If the demand for shipping falls, it's because consumer demand
is down. Decelerating consumer demand is bad for the economy.
'But wait, this is good
news' some say. FedEx's lowered earnings expectations are due to increases in
fixed pension and healthcare costs not falling consumer demand (or lack
thereof). Once again, FedEx may be the warning canary and that's not good news.
The effect the new
healthcare reform has on large corporations hasn't really been discussed much.
So let's examine the potentially huge impact on stock prices.
The Real Cost of the
Health Care Bill
Caterpillar, John Deere and
AT&T already announced non-cash charges of $100 million, $150 million and
$1 billion for 2010. This is based on the impact the new health care bill has
on forward retiree health care costs. As always, it pays to put things into
perspective.
Caterpillar reported
profits of $895 million, John Deere's profit was $912.80 million and AT&T's
profit was $12.54 billion. The unexpected healthcare charges make up 11%, 16%
and 8% of profits. These expenses should eventually hit the earnings per share
(EPS) and by extension the P/E ratio. Based on the above three examples, stocks
could be overvalued by 8% - 16%. The above-mentioned charges were for retired
employees only. Current employee healthcare costs were not considered yet.
Imagine the effect
increased health care costs of that magnitude could have on entire sectors such
as consumer discretionary (NYSEArca: XLY
- News),
consumer staples (NYSEArca: XLP - News)
and technology (NYSEArca: XLK - News).
Hungry for Profits
While Wall Street is hungry
for profits and analysts predict 2011 earnings would reach an all-time record
high (more about that in a moment), 1 in 8 Americans are simply hungry.
Reuters just reported that
nearly 40 million Americans were enrolled for food stamps during February.
'This is the highest share of the U.S. population on SNAP/food stamps,' said
the anti-hunger group Food Research and Action Center.
Enrollment has set a record
each month since reaching 31.78 million in December 2008. USDA estimates
enrollment will average 40.5 million people this fiscal year, which ends Sept
30, at a cost of up to $59 billion. For fiscal year 2011, average enrollment is
estimated to be 43.3 million people.
It's probably a fair (and
sobering) assumption that Americans who worry about their next meal don't worry
about the newest iPad or upgrading their car. Where is demand for new products
supposed to be coming from?
Watch Out for Earnings
Season
Time flies and earnings
season is just around the corner. Before we talk about the upcoming earnings
season, let's review the previous two.
In January 2010, most
companies beat their earnings forecast yet the S&P (NYSEArca: SPY
- News)
sold off as much as 9.2%.
On April 11, 2010, right
before the last earnings season began, the ETF Profit Strategy Newsletter
warned of the following: 'It is likely that the S&P will spike above 1,200
before retracing some of its recent gains. Various earnings reports will be
released this week. Buy the rumor, sell the news might be the theme for this
earnings season, as it was in January.'
The S&P closed above
1,200 for five trading days before reaching the April 26 highs. Even though
about 8 out of 10 companies beat their respective forecasts, the S&P sold
off as much as 14.68%. Imagine what will happen if earnings disappoint.
Yes, analysts tracked by
Thomson Reuters forecast earnings of $96.61 per share for the S&P in 2011.
This would mark a new all-time record and surpass the 2006 peak.
One can't help but wonder
how this earnings growth is supposed to be attained. 1 out of 8 Americans lives
on food stamps, 1.6 out of 10 Americans (according to the BLS's U-6
unemployment number of 16.6%) has no job and 1 out of 4 homeowners has a mortgage
that's under water.
Analyst's Paralysis
In addition to the
above-mentioned under-the-radar issues, we note that regulators have closed the
83rd bank (NYSEArca: KBE - News)
in 2010. The associated press reported on Thursday that new jobless claims are
up sharply as layoffs persist. Home building (NYSEArca: XHB
- News)
has plunged to a five-month low. According to the Department of Housing and
Urban Development, 643,000 people were homeless in January.
And finally, something Wall
Street will be taking note of, Bloomberg reported that new financial
regulations may cost financial companies (NYSEArca: XLF
- News)
billions of dollars. Of course analysts won't see the trouble until it becomes
glaringly obvious even to us 'average Joes.'
On April 26 when the major
U.S. markets (NYSEArca: TMW - News)
reached their recovery highs, Bloomberg reported; 'U.S. stocks cheapest since
1990 on analyst estimates.' One of the headlines in the Wall Street Journal
read that 'Technical analysts see room to roll.'
Quite to the contrary, the ETF Profit Strategy Newsletter noted on April
28, that 'the potential exists, that Monday's high - which was only one point
short of the 61.8% Fibonacci retracement at 1,220 - marked a significant top.
A significant top implies a
significant drop. How significant? The latest issue of the ETF Profit
Strategy Newsletter provides a detailed analysis along with a termination
range for this rally, the ultimate target range for a market bottom, and the
one chart that illustrates the bleak future outlook.