The S&P 500 and global indices were all higher yesterday and edging up today. Investors viewed strong manufacturing data released yesterday as a signal that the U.S. economic recovery is sustainable The data builds on analyst predictions that earnings will increase sharply this year.
The Institute for Supply Management's main monthly index jumped to 58.4 from 54.9 last month, the highest level since August 2004.
This was much higher than the 55.5 economists were expecting. Values over 50 in the index indicate manufacturing production is expanding.
The manufacturing data, combined with strong earnings reports over the past few days, created visions of economic recovery in the minds of investors. The result was a boost in risk appetite for investors who piled into equity and commodity markets yesterday and today.
Is Economic Growth Sustainable?
In less visible economic news yesterday, the government reported that income was higher by 0.4 percent in December and personal consumption expenditures rose 0.2 percent month-over-month. The personal saving rate moved higher by 0.3 percentage points to 4.8 percent in December, up from 4.5 percent in November. Consumer spending was up 4.0 percent, while income was up 0.5 percent.
An interesting chart from an article written by Michael Panzner at “The Big Picture” web site provides a more bearish perspective for the economy by comparing current income, spending, and savings data with data during the recession in the early 1980s.
Given these data, it is difficult to see how consumer demand regains a strong pace amid a stagnant job market and a rising personal saving rate.
Another chart useful for determining the strength of the economy is provided by Donald Marron in a recent article. The chart shows that inventory replenishment accounted for 3.4 percentage points of the total 5.7 percent GDP growth in the fourth quarter of 2009. Inventory rebuilds equaled about 60 percent of total economic growth for the quarter—a pace unlikely to be repeated for Q1 2010.
Based on the trends illustrated in the two charts above, the stage is being set for a new overhang of inventory and much slower economic growth. Inventory rebuilds are likely to slow in Q1 2010 given tepid consumer spending growth and rising saving.
Earnings Forecasts Help Drive Stock Market Higher
Despite the bearish economic scenario painted by the data, Wall Street analysts are predicting a V-shaped economic recovery for 2010 and 2011. Last week, industry analysts projected overall S&P 500 earnings will increase 28.9 percent from $60.98 per share in 2009 to $78.62 for 2010. In 2011, the analysts project an increase of 21 percent to $95.10. A reference point assuming a 14x price/earnings ratio implies the S&P 500 index should be at 1,331 a year from now, a 21 percent increase from current 1,100 S&P 500 index levels.
These optimistic projections are based on recently released fourth quarter 2009 earnings. Here are a few examples.
Amazon.com's (AMZN) fourth quarter earnings jumped 71 percent over last year for the fourth quarter due to strong holiday season sales. It also beat the street by 18 percent. The company earned $384 million, or 85 cents per share, versus $225 million, or 52 cents per share in the same quarter a year ago. Analysts were expecting 72 cents a share.
Microsoft (MSFT) profits beat consensus analyst estimates by 25 percent, jumping 60 percent from last year in its most recent fiscal quarter due to a rebound in personal computer sales and higher sales of its Windows 7 operating system. Profits for the quarter wesr $6.7 billion, or 74 cents per share, versus $4.17 billion, or 47 cents per share for the same quarter of 2008. The consensus estimate was for 59 cents per share in earnings.
Exxon Mobil's (XOM) fourth-quarter net beat consensus estimates despite income falling 23 percent to $6.05 billion, or $1.27 a share, from $7.82 billion, or $1.54 a share in the year-ago period. Wall Street expected profits of $1.17 a share.
Chocolate candy manufacturer Hershey (HSY) reported a 54 percent increase in profits for the fourth quarter and raised its dividend amid a strong growth outlook for 2010. The company earned 63 cents a share in the fourth quarter, excluding special items, up from 36 cents a share for the fourth quarter of 2008. Analysts were expecting earnings of 60 cents a share.
Friday Employment Situation Report is Critical
As a result, Friday's employment report for the week will be important for stocks. The unemployment rate was 10.0 percent in December and economists are expecting a 10.1 percent rate for January. Economists expect average hourly earnings to grow 0.2 percent and the average workweek to stay level at 33.2 hours.
If the jobs report shows strong improvement in hiring and lower unemployment, consumers could gain more confidence, boosting consumption and drawing down inventories in the first quarter of 2010. In this case, analyst earnings projections might be on target. Any deterioration from economist's expectations on employment, average hourly earnings, or the average workweek and the markets could begin a sustained downward drop.
Conclusion
Markets go up and markets go down. Right now, there are considerable economic headwinds that the equity markets must overcome during 2010 if they are to meet analyst expectations. Market sentiment for February could rise or fall on Friday’s employment situation report. Stay tuned.
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