One axiom of financial market analysis is that securities prices are forward-looking; that is, today's stock prices reflect the expected value of tomorrow's earnings. This indicates that broad market indexes should be tanking if corporate earnings are expected to decline further:
The earnings estimates keep getting revised downward, yet the S&P stubbornly refuses to close below 8000 (except briefly on Nov. 20). What is sustaining this market's optimism if poor earnings are not fully reflected in securities prices? Let's consider some possible factors.
Hedge fund withdrawal suspensions. Hedge funds and their fund-of-fund gatekeepers continue to prevent their constituent investors from withdrawing money. This reduces pressure on the funds to sell their equity holdings to meet cash redemption demands.
Fiscal stimulus plans. The potential for massive Federal infrastructure spending in 2009 gives hope to equity investors. Unfortunately, federal contract awards have long lead times; government agencies have to plan projects and publicize RFPs, contractors have to submit bids, etc. The spending itself may not lift corporate earnings until Q409 or later given these lags.
Fed quantitative easing. Here's where things get interesting. The Fed has accepted assets of questionable quality onto its balance sheet as collateral for loans to banks under the Term Asset-Backed Securities Loan Facility (TALF) and other programs. These loans have temporarily revitalized the credit markets and given a reprieve to banks' stressed balance sheets. Without Chairman Bernanke's helicopters in the air dropping TALF money, many businesses would be starved for short-term credit.
Remove any one of these props and the market loses valuation support. The financial class is hoping for a long, slow unwind that leads to a soft landing for equities in 2009. This outcome retains public confidence in our governing institutions and minimizes social disruption. We can only hope.
Nota bene: Anthony J. Alfidi is short uncovered calls on SPY at the time this commentary was published.
Earnings for Standard and Poor's 500 .SPX companies are now forecast to decline in the final three months of 2008 by 0.6 percent from a year earlier, according to Wednesday's Thomson Reuters Director's Report, a daily analysis of earnings trends for the companies comprising the benchmark U.S. equity index.
The earnings estimates keep getting revised downward, yet the S&P stubbornly refuses to close below 8000 (except briefly on Nov. 20). What is sustaining this market's optimism if poor earnings are not fully reflected in securities prices? Let's consider some possible factors.
Hedge fund withdrawal suspensions. Hedge funds and their fund-of-fund gatekeepers continue to prevent their constituent investors from withdrawing money. This reduces pressure on the funds to sell their equity holdings to meet cash redemption demands.
Fiscal stimulus plans. The potential for massive Federal infrastructure spending in 2009 gives hope to equity investors. Unfortunately, federal contract awards have long lead times; government agencies have to plan projects and publicize RFPs, contractors have to submit bids, etc. The spending itself may not lift corporate earnings until Q409 or later given these lags.
Fed quantitative easing. Here's where things get interesting. The Fed has accepted assets of questionable quality onto its balance sheet as collateral for loans to banks under the Term Asset-Backed Securities Loan Facility (TALF) and other programs. These loans have temporarily revitalized the credit markets and given a reprieve to banks' stressed balance sheets. Without Chairman Bernanke's helicopters in the air dropping TALF money, many businesses would be starved for short-term credit.
Remove any one of these props and the market loses valuation support. The financial class is hoping for a long, slow unwind that leads to a soft landing for equities in 2009. This outcome retains public confidence in our governing institutions and minimizes social disruption. We can only hope.
Nota bene: Anthony J. Alfidi is short uncovered calls on SPY at the time this commentary was published.
