Earnings Season–Fighting the Last War

The financial media has the effect of reinforcing some of the most counter-productive tendencies identified by the behavioral finance literature, described in prior posts.  On a day like today, with the market down big time, CNBC brings in those who can "explain" what has happened.  The selection bias gives the illusion that there are all of these wise heads who are figuring this stuff out in advance.

Here is the edge for the savvy investor.  Most people are dramatically influenced by early occurrences in their lives or careers.  Most hedge fund managers are pretty young, and perhaps unduly influenced by the "internet and tech bubble."  They also have in their (brief) careers some experience with corporate accounting issues, deception, lying by sell-side research analysts to foster investment banking business, a myriad of one-time charges, and other elements that exaggerate earnings.

Like  the Nobel Prize winning Pavlov‘s dogs, they have learned to be suspicious of any earnings forecast.

The problem?  They are fighting the last war!

This one is over.  The world has changed.  (There is this child’s game played by pundits, where if you dare to say that "thing’s are different" you lose.)  Well it is different to anyone who is not wearing blinders.  At "A Dash" we read hundreds of analyst reports on the stocks we follow and the changes are apparent.  Here is what has taken place:

  • Companies are much cleaner in their earnings reports.
  • Options expensing has been mandated by FASB.
  • Companies are extremely careful in their forward- looking statements.  This is not even close to the cheeleading days of 1999 and 2000.  I followed interviews in 2003 very carefully, and CEO’s were all conservative in front of the Iraq war.  Companies do not give encouraging guidance unless they can really see it.
  • Sell-side analysts are more conservative — much more conservative.  They have a higher number of "hold" and "sell" ratings, even though the coverage universe is smaller.
  • Analysts try to guess the economoy to find some sell ratings.  When the specific information from the company does not justify lowering earnings, they produce some authentic Wall Street Gibberish about how this is the peak of the cycle.  That means that they have decided to predict the economy, instead of following their stock.

Pundits who are stretching the mileage from their "bubble era" analysis, continue to say that analyst estimates are exaggerated and "must come down" even though these estimates have already been normalized, discounted, and discounted again.

There are many pundits and hedge fund managers who harbor this view.  For some time now, when the prediction has been incorrect, the PE multiple for stocks has just gone lower.  Since "everyone" knows that earnings will move lower, it makes sense to "bake in" a lower multiple.

The next segment will see how that approach has worked…..

Fed Predictions

If we did not have money at stake, the various predictions about the Fed would be amusing.  Every day the parade of the pundits on CNBC includes those who talk about what the Fed should do and what the Fed will do.

With a very vew exceptions, most of those offering opinions about what they should do are completely clueless.  I have a new person in my office, a very bright, young almost-graduate from a good local university.  (The Old Prof looks for this sort of person, since I accept the adage that "you can’t coach speed."  We look for bright people who want to show what they can do and then give them the chance.  They have to be friendly and coachable as well, since there is a lot of give and take in our educational process.)  Anyway, she noted that most of those appearing on CNBC seemd to be spouting cliche`s rather than analyzing.  She almost has her finance degree.  The particular commentator had said something about the "pulling away of the punch bowl was ruining our dead cat bounce" so her point was valid.

Since anyone can join in this, let me add a few predictions.

  1. At the beginning of the cycle, the Fed set out to get to neutral, not to slow the economy.  At the time, that might have been 3.5% to 4% on the Fed Funds rate.  Since inflation (using the approved Fed measures) has crept a little higher, neutral is probably now about 5% or a touch higher.
  2. If you understand how the Fed and the staff thinks, and how monetary policy works, you realize that the interest rate hikes have not been a restrictive factor until very recently.  In fact, even today, a top economist was arguing on CNBC today that the rate hikes are still not restrictive.  This is extremely different from the view of many pundits and hedge fund managers (led and exemplified by Doug Kass — a savvy and high-profile guy on Cramer’s site and CNBC).  They have been viewing even the early rate hikes as "headwinds."
  3. Fed policy lags by six to nine months.  They know that, as does any economist.  That means that we are only beginning to feel the effects of Fed tightening, and we’ll see more in the next few months.  This is an expected, predictable slowdown in the rate of economic growth.  It is not a recession or stagflation or whatever else the worrywarts are projecting this week.
  4. No one knows what the Fed’s next move will be, including me.  The reason is that they do not yet know themselves.  They know that it is all data driven, and that there are lags.
  5. Having said all of this about the difficulty of predicting, I would not be surprised to see the Fed pause for a bit to get more information.  This might be accompanied by tough talk, since they want to contain inflationary expectations.
  6. If there is a spike in oil prices, world turmoil, or any number of other bad things that might happen, the Fed will not raise rates and might lower them.

People forget that the Fed has a dual mission that includes economic growth.

Redux: Household versus Establishment

While Barry Ritholtz’s blog is a big favorite for lots of us, I do not think that David Malpass, Chief Global Eocnomist for Bear Stearns, is going to drop by to comment on the employment numbers.

His work in the current cycle has been brilliant — right on target throughout, so let me summarize a few points.  The key idea is that he thinks the Household survey is a lot better.  But look first at the background from Barry, including some great charts from the BLS.

Link: Redux: Household versus Establishment.

One last item: The Labor Department’s payrolls report is also at odds with its own survey of households, which is used to calculate the unemployment rate. The household survey showed employment grew by 387,000 in June, in line with ADP’s figures.The …

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