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Ahead of Wall Street - July 18, 2012

Sheraz Mian

Wednesday, July 18, 2012

The market can’t seem to make up its mind about interpreting Ben Bernanke’s comments, particularly with respect to the need and timing of more QE. But the simplest explanation could very well be that the Fed, like everyone else, is watching the economy slow down and looking for confirmation of whether it’s something temporary or more enduring. But keeping aside the question of how effective more QE will be in reversing the slowing trend, one can be reasonably sure that the Fed will ‘do something’ should the slowing trend get confirmed.

For many, myself included, the sub-par jobs and retail sales reports of recent months provide plenty of evidence that the economy has slowed. But perhaps the Fed needs to confirm this trend with more data in the coming days. Bernanke will again be testifying today, this time to the House, and will perhaps be a little clearer today in building and anchoring the market’s expectations.
Bernanke aside, we got a mixed housing report this morning, with Housing Starts better than expected and Permits coming in lower than expected. This is a complete reversal of what we saw last month when Permits were stronger than the Starts.
The June Housing Starts data came in better than expected, up 6.9% to a seasonally adjusted annual rate of 760K, compared to the 4.8% drop in May to 711K. Permits were down 3.7% to 755K, reversing the strong 8.4% gain to 784K in May. The strength in Starts was both in single family and multi-family starts, with most regions of the country showing gains. This is the highest Starts level since late 2008 and further confirmation of the positive momentum on the housing front.

We should keep in mind however that the improvement is from a low base as the long-term historical average for Starts is around double the current level, while Starts at the ‘bubbly’ peak were north of the 2.2 million mark. We will probably never go back to that level, but we do need to see a sustainable recovery in this key sector of the economy. Sales and inventories have stabilized, but a pricing recovery will like take much longer given the shadow inventory of foreclosure pipeline and the recent loss of momentum in the labor market.

The second quarter 2012 earnings season is in full swing and the picture that is emerging appears to be less bad relative to pre-season fears. Results for the big banks, including from Bank of America (BAC) this morning, have met or exceeded earnings expectations. That said, revenue gains are difficult to come by and the overall tone of company guidance is on the weak side. Intel’s (INTC) results after the close on Tuesday were far better than what we saw from Advanced Micro Devices (AMD) a few days back, but they nevertheless also have revenue issues. It is hard to tell whether Intel’s top-line ‘problem’ is a function of the global economic slowdown or the secular demand shift from PCs to tablets is hard to tell at this stage, but we are seeing many companies struggle with revenue gains.
Total earnings for the 52 companies that have reported results as of this morning are down 2.3% from the same period last year, while earnings for these same companies were flat (up 0.5%, to be precise) in the previous quarter. After a fairly weak start, the ratio of companies beating earnings expectations has steadily improved. As of this morning, 67% of the companies have beat expectations, with a median surprise of 2.5%. This is weaker than what we saw from these same companies in the first quarter, when 75% beat expectations and the median surprise was 3.9%. Bottom line, the second quarter earnings season is weaker than what we have been seeing in recent quarters, but corporate profits are not falling off the cliff either. But all this could change in the coming days as roughly 90% of the reports are still to come.
Sheraz Mian
Director of Research

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