There’s a blog that summarises the Wall Street Journal on the corresponding day in 1930, and one thing that comes through loud and clear is that they didn’t know they were having a Depression.
In fact, at this point they were reporting that US earnings for the June quarter were better than expected and that sentiment was improving. The market was “dull”, but that was mostly because of a heat wave in New York.
Of course, the timing is out of whack. The market crashed in October 1929 whereas the GFC began in August 2007 – nearly two years ago. Then again, perhaps the collapse of Lehman Brothers is more analogous to the Great Crash of 1929 than the freezing by BNP Paribas of three investment funds because of US subprime losses in August 9, 2007.
Anyway, once again profits are better than expected and the temperature in New York City is a mild 25 degrees Celsius this morning our time (although it’s raining cats and dogs).
Forty per cent of the S&P 500 has reported for the second quarter and average earnings per share have fallen 25% year-on-year (20% for financials) but have beaten consensus forecasts by 11%. Three-quarters of companies have beaten expectations.
As a result of this, and better news on housing, financial conditions and manufacturing conditions, the market is running hard – although last night’s was more a consolidation session, with the Dow Jones settling in above 9000 (profits were still coming in above expectations, notably Verizon). The ASX 200, meanwhile, is consolidating above 4000 and the Nikkei in Japan above 20,000.
Last week I wrote that the market was running on an absence of negatives, and that it looked more like a bear market rally than a new bull market.
That’s all still true, but it’s worth repeating that just about everything except the sharemarket has now wiped out the Lehman effect – as I pointed out last week, the market has recovered about half what was lost during the Lehman panic, whereas the financial conditions index and various purchasing managers’ indices are back to where there were in July last year.
In particular, the inventory cycle will produce a big lift in global output in the second half of this year, and virtually every company in the world has now drastically reduced costs to prepare for the worst.
Output fell more than final demand during the Lehman panic last year, and as a result inventories everywhere were cleared out. Restocking is now leading to a big increase in production, which is likely to have a big short-term impact on profits because of cost savings.
Yesterday, my colleague Robert Gottliebsen talked about a car dealer whose sales have slumped following the end of the financial year because the bonus depreciation brought sales forward into June.
But then later yesterday, another car dealer wrote to me saying that he had cut his staff permanently from 600 to 550 by “getting rid of the drones”. “In good times we got slack,” he added, so he’s putting it all in a journal for his children. So while sales may be soft, he says, profits have never been better.
These are just a couple of stories, but I talk to many business people and it’s clear that permanent and substantial cost reductions have been commonplace over the past six months.
If production snaps back rapidly in the second half because of the inventory cycle, as seems likely, the effect on bottom lines could be quite dramatic.
Yes, the economic recovery may well prove unsustainable because of rising unemployment (resulting from all the cost-cutting among businesses), but we won’t know that until well into 2010. Certainly it’s unlikely that central banks will start raising interest rates until then.
In the meantime, the market can see what’s likely to happen to profits and is anticipating that. So the three-month, 30% rise in the market is unlikely to be lost in a hurry, and is more likely to be built upon in the coming months as earnings forecasts are upgraded in the lead up to Christmas and beyond.
Then again, on roughly this day in 1930, with profits beating expectations, the Wall Street Journal reported the consensus that “business will improve seasonally in fall” and that optimists expected the improvement to continue through winter.
As Mao Zedong said: “Complacency is the enemy of study”.
This article first appeared on Business Spectator.
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