Grim results and downward revisions restrict investor confidence
and present opportunities.
Words by Bryan Snelson
Misery certainly does love company! There’s been no shortage of bad news presented to investors this summer; so much so that after a while the meaning of each news story, each point of data can become blurred. The question you need ask yourself with every crisis du jour is this: “is this a threat or an opportunity?” The answer isn’t always obvious and can be a complete enigma unless you understand what moves share prices.
Here’s one cog in the wheel for you to consider: Recent U.S. employment numbers were astonishingly weak, underscoring what has become a pattern of continued labour market malaise. The U.S. economy added just 18,000 jobs in June – way below the 105,000 that had been anticipated. The U.S. unemployment rate, which has remained stubbornly high in spite of hundreds of billions of dollars in fiscal and monetary stimulus was forecast to dip to 9% from 9.1%. Instead, it actually rose to 9.2%! At this pace, it will take more than four and a half years to recover the remaining 6.9 million jobs lost during the recession. Were that to be the case, it is going to take a very long time to get the massive oversupply of unsold U.S. homes down to size. Stabilization, let alone a recovery in the housing market is cited by many economists as a necessary ingredient for the U.S. economy to finally shake off the last vestiges of the 2008 – 2009 recession. So is this a threat or an opportunity?
Share prices are helped or hurt by earnings expectations; specifically the expectation that the economic backdrop is going to make corporate earnings growth either easier or more difficult. That is the essence of what every investor has to take into consideration. For investors who prefer to invest close to home, our local market index, the TSX composite index is heavily populated by the kind of companies that are known as cyclicals. Cyclical stocks are able to grow their earnings in the fertile soil of a strong economy. It is for this reason that Canadian investors, mutual fund, exchange traded fund and stock pickers alike need to pay attention to the economic tea leaves to help form an opinion on the state of economic growth, especially in The United States; Canada’s largest trading partner by far. It’s not just enough though to form an opinion on whether economic output is expanding or contracting. You’ve got to hold your economic viewpoint up against what the analysts have to say about earnings. Analysts are also looking at the economy and using their assessment of the economic situation when forecasting corporate earnings, sometimes revising their estimates up or down depending on what, among other things the economic data is telling them. Roughly 60% of analyst’s second quarter earnings revisions for members of the TSX composite have been downward revisions, the highest level in quite some time. It may just be that a lot of bad news is already baked in to earnings expectations, setting a hurdle that could be relatively easy for many companies to step over.
The point of the exercise is not to capture the absolute state of the economy or corporate earnings. You’re looking for directionality. Are things getting better or worse? Are expectations low or suffering from so much irrational exuberance? The best bargains are found at times of low expectations and a muddy economic outlook. Warren Buffet captured this sentiment when he wrote in a letters to shareholders; “You pay a very high price for a cheery consensus.”
Bryan Snelson is a Vice President, financial advisor and branch manager with Raymond James Ltd. Mississauga. His views do not necessarily reflect those of Raymond James and his article is for information only. Raymond James Ltd. is a member of The Canadian Investor Protection Fund. Bryan’s financial market reports can be heard daily at 6:45 am at 4:40 pm on the Toronto radio station JAZZ FM91.