Market Climbs A Wall of Worry

The proverbial saying that the market climbs a "wall of worry" has certainly proven its veracity since the end of February. I suggested immediately after the plunge on 2/27 that it was a buying opportunity based on what I understood as the reasons for the market drop. Even though I was correct, If I had known then what would develop during the following month, I would not have made such a call.

March was a fairly negative month in terms of what the market had to deal with, none of which was known at the time of the sell off; the sub prime lending meltdown, sharply higher oil prices and tensions aka Iran, renewed trade tensions with China, continuing weaker than expected economic data ( excl. the latest job data) and domestic political squabbling over everything.

What accounted for the strength? Fundamentally, it was the Fed's removal of the tightening bias and the market's perception that rate cuts were more imminent due to an economic slowing and sub prime fallout. I believe a lot of the resiliency can be attributed to the ever increasing private equity onslaught combined with a growing "let's do a deal" mentality in most executive suites, continues to put a floor under U.S. stock prices.

Some are suggesting that the rush of private equity firms to go public indicates a top in that area, and while I would have my doubts, it certainly is interesting that they are going public, while trying to take everyone else private. But it actually makes sense, because they can now issue "stock options" to attract managers while the principals can cash in a portion of their equity. Anyhow, its not really a contradiction, because they plan to take those same companies public again, as soon as feasible.

Employment Data

Recent economic data and anecdotal evidence had been consistently pointing towards economic slowing with weakness coming from both the consumer and corporate arenas and "bingo" on a holiday Friday the March employment report comes out much stronger than expected. Based on the components of the employment report, builders added 56.000 jobs after shedding 61,000 the previous month and a 36,000 gain in retail, says a lot about a significant weather related impact from an exceedingly cold February. Manufacturing jobs just continue to vanish with a decline of 16,000 during March, as practically all job growth is in the service sector. However, both January and February job gains were revised up a total of 32,000.

Interestingly, when one examines the ADP employment data reported a few days earlier, which is based on data from 365,000 businesses, not only does it confirm all the gains are from the service sector, but most of the job gains appear to be in small companies with fewer than 49 employees, while mid size companies with fewer than 499 employees, accounted for the remainder of the job gains, while companies employing more than 499 had a decline of 18,000 jobs.

There is no question that statistically the job market remains solid as the unemployment rate of 4.4% fell back to its lowest level in the last five years. One might question the quality and permanence of the types of jobs created during this latest six year economic cycle compared to the quality of jobs lost.

First Quarter Earnings

If larger corporations are not adding jobs, could it be that profit and revenue growth is finally slowing as this lengthy economic cycle shows age? I think the evidence is starting to mount and should be more evident with the first quarter earnings reports, starting this week. While there has not been a flurry of earnings' warnings as the quarter closed, (maybe executives have been too busy examining deals, old option dates, and restating prior earnings) expectations have been steadily declining since the beginning of the year.

The consensus is now estimating first quarter S&P 500 earnings growth of 3-4% down from 8-9% in January. The estimated growth for the year is now in mid-single digits down from low-double digits.

I see companies making their numbers mostly from foreign currency benefits, and share buybacks, or lower tax rates, not from organic growth. I also expect an increasing number of companies will be lowering their guidance, in many cases to where analysts already have, or below for the coming year. I think the trend will also be moving toward providing less guidance or discontinuing guidance entirely as it becomes harder to beat.