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Generational Dynamics Web Log for 16-Nov-07
Third quarter corporate earnings are substantially below expectations

Web Log - November, 2007

Third quarter corporate earnings are substantially below expectations

Stocks have been falling pretty steadily since the October 9 high at Dow 14164. Here's the most recent data from my Dow Jones historical page:

Date              DJIA (Change)   (% of trend)      (% of 2007 high)
----------------- --------------  ---------------- ----------------
Tue 2007-10-09  14164.53( +0.86%) (267% of 5302.8) (100% of 07-10-09) [October 9, 2007]
Wed 2007-10-10  14078.69( -0.61%) (265% of 5303.5) ( 99% of 07-10-09)
Thu 2007-10-11  14015.12( -0.45%) (264% of 5304.2) ( 98% of 07-10-09)
Fri 2007-10-12  14093.08( +0.56%) (265% of 5304.8) ( 99% of 07-10-09)
---------------------------------------------------------------------
Mon 2007-10-15  13984.80( -0.77%) (263% of 5306.8) ( 98% of 07-10-09)
Tue 2007-10-16  13912.94( -0.51%) (262% of 5307.5) ( 98% of 07-10-09)
Wed 2007-10-17  13892.54( -0.15%) (261% of 5308.1) ( 98% of 07-10-09)
Thu 2007-10-18  13888.96( -0.03%) (261% of 5308.8) ( 98% of 07-10-09)
Fri 2007-10-19  13522.02( -2.64%) (254% of 5309.5) ( 95% of 07-10-09)
---------------------------------------------------------------------
Mon 2007-10-22  13566.97( +0.33%) (255% of 5311.5) ( 95% of 07-10-09)
Tue 2007-10-23  13676.23( +0.81%) (257% of 5312.1) ( 96% of 07-10-09)
Wed 2007-10-24  13675.25( -0.01%) (257% of 5312.8) ( 96% of 07-10-09)
Thu 2007-10-25  13671.92( -0.02%) (257% of 5313.5) ( 96% of 07-10-09)
Fri 2007-10-26  13806.70( +0.99%) (259% of 5314.1) ( 97% of 07-10-09)
---------------------------------------------------------------------
Mon 2007-10-29  13870.26( +0.46%) (260% of 5316.1) ( 97% of 07-10-09)
Tue 2007-10-30  13792.47( -0.56%) (259% of 5316.8) ( 97% of 07-10-09)
Wed 2007-10-31  13930.01( +1.00%) (261% of 5317.5) ( 98% of 07-10-09)
Thu 2007-11-01  13567.87( -2.60%) (255% of 5318.1) ( 95% of 07-10-09)
Fri 2007-11-02  13595.10( +0.20%) (255% of 5318.8) ( 95% of 07-10-09)
---------------------------------------------------------------------
Mon 2007-11-05  13543.40( -0.38%) (254% of 5320.8) ( 95% of 07-10-09) [October 9, 2007]
Tue 2007-11-06  13660.94( +0.87%) (256% of 5321.5) ( 96% of 07-10-09)
Wed 2007-11-07  13300.02( -2.64%) (249% of 5322.1) ( 93% of 07-10-09)
Thu 2007-11-08  13266.29( -0.25%) (249% of 5322.8) ( 93% of 07-10-09)
Fri 2007-11-09  13042.74( -1.69%) (245% of 5323.5) ( 92% of 07-10-09)
---------------------------------------------------------------------
Mon 2007-11-12  12987.55( -0.42%) (243% of 5325.5) ( 91% of 07-10-09)
Tue 2007-11-13  13307.09( +2.46%) (249% of 5326.1) ( 93% of 07-10-09)
Wed 2007-11-14  13223.93( -0.62%) (248% of 5326.8) ( 93% of 07-10-09)
Thu 2007-11-15  13110.05( -0.86%) (246% of 5327.5) ( 92% of 07-10-09)

The last line of this shows the following:

On November 15, the Dow was at 13110.05, having fallen 0.86% that day.

The "real value" of the stock market, as described in my essay, "How to compute the 'real value' of the stock market," is Dow 5327.5 That means that the stock market is overpriced today by a factor of 246%, a huge bubble.

The value of the Dow is 92% of October 9 high.

Why has the market been falling? Is it because our bubblehead investment community has finally developed a little sense? I guess it's possible, but in view of the moronic display we've been seeing in the past, that doesn't seem likely.

My guess is that they're getting scared. In fact, that's what Generational Dynamics predicts, as I've said many times. The Boomers only know how to argue; they have no idea what's going on, since their parents' generation always took care of everything for them. The Generation-Xers are even worse; they don't have idea what's going on either, but they're driven by a nihilistic view of the world that causes them to be destructive and self-destructive. How else can you explain the existence of $750 trillion of CDOs and other credit derivatives, much of which may turn out to be worthless?

But not having any idea what's going on means that you don't know what to do when all your assumptions are wrong.

For years, one assumption has been that earnings per share would continue to grow at double-digit rates, something that hasn't happened for long historically.

Well, now the long-awaited fall in corporate earnings seems to be happening, as of the third quarter. Here's the summary from CNBC's earnings central:

"As of Friday, November 9th: 451 companies in the S&P 500 have reported earnings for third-quarter, 64.30% have beaten estimates, 11.31% were in-line, and 24.39% have missed. (Data provided by Reuters Estimates)

The blended earnings growth rate for the S&P 500 in third-quarter 2007, combining actual numbers for companies that have reported, and estimates for companies yet to report, fell to -2.4% from -1.6% last week, and below the 3.6% estimate from October 1st. On July 1st, the estimated growth rate was 6.2%. (Data provided by Thomson Financial)

In other words, as of July 1, our financial gurus expected third quarter earnings to grow by 6.2%; instead, earnings have FALLEN by 2.4%. And that's even worse than expected just last week.

This pulls the rug out from under the standard bubblehead investment strategy that we keep seeing. Now things are changing.

Formerly, the subprime mortgage bubble fed into a huge credit bubble (by means of CDOs and other credit derivatives backed by faulty mortgage contracts), which provided cash to corporations to generate bubble earnings, which caused historically high earnings growth, which investors used to justify high price/earnings ratios on stocks.

Now with the bubble credit bubble deflating, there's less money around, and it's harder to generate bubble earnings, which means that stock prices have to fall to maintain the same price/earnings ratios.

But there's more, and this is an interesting angle pointed out by Kevin Depew in the Minyanville blog. He quotes Karen Hoguet, CFO of Macy's.

Macy's had been planning to buy back $1 billion of its own stock before the end of the year. But now with the credit bubble collapsing, these plans are in doubt, according to Hoguet:

"Given the current condition in the credit markets, we are carefully evaluating our options with respect to the timing of completing our remaining $1 billion authorization. As a result, some or most of that $1 billion could end up being deferred into next year. While we are optimistic about our prospects, and we believe the stock today represents a great value, we do need to balance this with the benefits of preserving access to all financial markets during these volatile times in the credit market."

Now here's the gimmick: Macy's and many other companies had been using money from the credit bubble to buy back their own stock for years. Why? It reduces the number of outstanding shares of stock for the company. By reducing the number of shares, the "earnings per share" computation increases (because you're dividing by a smaller number of shares outstanding), and that's the same as the price/earnings ratio. So companies have been reducing the price/earnings ratio of their own stock by using credit bubble money to buy back shares of their own stock.

Now that window is being closed down, and Macy's and other companies are forced to defer their stock buyback plans. Here's some more from Hoguet:

"The truth is that's why we give a range of estimates. If we don't buy back the billion dollars, obviously the operations are going to have to do better to get to the same earnings [per share]. But that is part of the reason we give a range. You know, it's not as precise as you all think to estimate earnings going forward. So we do the best that we can as we provide guidance."

So CFO Hoguet is saying that Macy's will have to WORK for those earnings per share, rather than get them automatically through stock buybacks.

What we're seeing is a stock market collapse proceeding step by step. We haven't seen a total panic yet, but it's coming. It would be a truly wondrous thing to behold if the consequences weren't so disastrous.

From the point of view of Generational Dynamics, we're overdue for a stock market panic and crash. It might come next week, next month or next year, but it's coming with absolute certainty. (16-Nov-07) Permanent Link
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Generational Dynamics Web Log for 16-Nov-07 Third quarter corporate earnings are substantially below expectations

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Generational Dynamics Web Log for 16-Nov-07
Third quarter corporate earnings are substantially below expectations