Will Earnings Eventually Support the Stock Market Rally?

Since closing at 676.53 on March 9th, 2009, the S&P has rallied some 63.7% to its current level of ~1108. Some market pundits attribute this meteoric rise to the Fed's unprecedented market intervention(s), which has created massive amounts of liquidity. Other skeptics call it another round of irrational exuberance; a short-lived bull market within a cyclical (or secular?) bear market. Still others say this rally is for real, that the equity markets typically look 6-9 months into the future, and that only the fools are still on the sidelines.

Granted, stocks have become relatively non-cheap, at least in terms of the multiples of reported earnings which they're trading. The real question behind this debate however, is "Whether corporate earnings will catch up to, and eventually support, the current stock market's trading range". Before I attempt to answer that question, I'd like to first frame the argument in terms of the psychological basis from which each side is attempting to further its argument.

The first point I need to make is that this economy IS recovering. However, the rising tide is not lifting all boats. I wouldn't want to be D.R Horton right now, but I wouldn't mind being Intel. Most of all, I would not want to be a small business; they have effectively been denied access to nearly all sources of credit, they aren't large enough to throw their weight around with suppliers, and oh yea, health insurance premiums are about to go up. Given this set of facts, its easy to see why nearly every small business owner in this country is quite pessimistic at this moment. Furthermore, small businesses don't use - or even understand for that matter - GAAP accounting. Their focus is on cash in v. cash out, i.e small business income statements are usually just two lines: sales and costs. Therefore, profit boosting concepts like LIFO liquidations and unrealized gains on trading securities are somewhat foreign, effectively obfuscating their perception of recent corporate profit increases. Psychologically, they are mad; the government bailed out big business and didn't throw them a crumb. Watching the stock market rise on a daily basis simply angers many small business owners.

On the flip side, big business reacted quickly and viciously to the Great Recession; they laid people off in the thousands and shuttered profitable plants/mills just to achieve higher asset utilization rates. The result was the temporary occurrence of costly restructuring charges. The largest of these are probably behind us though, meaning that bottom lines will be juiced in the coming quarters. The next advantage available to big business is global scale; there may be little US based sales growth in the months ahead, but developing markets continue to grow. Given this set of facts, many large corporations that operate in a handful of industries have reason to be cautiously optimistic.

Don't think for a minute that the current stock market bulls v bears argument isn't completely driven by this psychological and economic dichotomy. Bulls typically cite the earnings cycle, proposing that the following sequence of events will lead to an earnings - and an economic - rebound:

1. Corporation's cut costs
2. Productivity Increases
3. Profits begin to increase
4. Inventories are replenished
5. Capital Expenditures are made
6. Hiring resumes
7. Consumption rebounds

In contrast, the bears are either in denial that corporate profits will increase, or (the more sophisticated ones) would say that once inventories are replenished, firms will hold onto cash and the capital expenditures will never materialize. From my perspective, the resumption of hiring looks to be the major impediment to a recovery. When hiring does resume, it will be at the largest, healthiest multi-national corporations. Furthermore, those hired first will the most educated and most able to add value to the firm. Housing and construction may never return to pre-recession employment (absolute) numbers, and manufacturing jobs will continue to be lost to a combination of technology and China. This doesn't bode well for the consumer as a whole, whom I expect to behave anemically for another 3-7 years.

That all being said, the answer to the title to of this post is something to the effect of "some of them". It's up to individual investors to figure out which firms have the global scale and management capacity to go out and find (take?) new sources of revenue, whether it be via acquisitions or expansion into new markets. Beware of dead business models.  Sphere: Related Content

Adecco Results Confirm Jobless Recovery

Adecco Group, a Zurich based human resources company, yesterday posted dismal Q2 results; no matter which line of the income statement you'd prefer to look at. Top line was down 31% from the prior year's quarter - a relatively disappointing hit to revenue; that is until you drop down to EBITA for the quarter, which declined 90% from Q2 '08. Breaking the results out geographically, revenue for the US & Canada came in only slightly better at -29%.

How is this relevant to the employment situation? Adecco Group's euphemism of a business description - Human Resource services - is known colloquially as a Temp Agency. Adecco isn't just any temp agency though; it's a Fortune 500 Global Company that operates in 60 countries, and supplies roughly 500,000 workers to 100,000 clients each Day. Furthermore, the Company provides more than just the stereotypical temp who shuffles paper and is gone after a week; much to the contrary, Adecco matches workers up with clients who require a wide-range of skill sets, including those in the Finance, Legal, Medical, Scientific and Information Technology industries. They are (to steal a line from the Dos Equis commercials) the most representative employment agency...in the world.

The post-Lehman economic shock caused many businesses to slash payrolls at a merciless rate in order to contend with a shrinking top line. As the economy bottoms out and businesses gain confidence, they are expected to look disproportionally towards temporary and contract workers - you know, the kind that don't require severance packages. That being said, Adecco Group is likely to be one of the first corporations to feel the effect of a turnaround in the labor market. Perhaps they should even be viewed as a leading indicator of the labor markets in North America and Western Europe. Regardless, the Company's precipitous drop in revenue does not bode well for the near term labor market outlook.

*no position in Adecco Group Sphere: Related Content