NOTE: Every week or two I write a Client Note for my clients. For a limited time, I am allowing non-clients to sign up and receive it at the same time as my clients. You can sign up at the top right hand corner of the website. I will also be posting the notes on my blog with a time delay from time to time.
Originally sent to clients April 3.
With the 1st quarter having ended last week, the next big item on the Wall Street calendar is earnings season. Early indications suggest it will not be a good one.
Helping us get a gauge are two important companies whose fiscal quarters end a month early: Federal Express (FDX) and Nike (NKE). Both companies reported earnings two Thursdays ago (March 22).
While the surface numbers looked okay at both companies, a closer inspection shows some worrying trends. At FedEx, US volume in its key Express division declined 4% year over year. Only a 9% increase in US revenue per package made the economics work.
Basic economics teaches that, all other things being equal, price increases lead to a decrease in quantity. You can only increase prices so far before customers cut back and find substitutes. Indeed, FedEx customers seem to be substituting Ground shipment for Express to some extent. Also note that sharp drops in volume at FedEx’s Express division have correlated with each of the last two recessions. (Note: the chart includes domestic and international Express volumes).
A similar kind of thing can be seen in Nike’s report. While the top line represented by revenues and future orders were quite strong (both +15%), a 2% decrease in gross margin squeezed Nike’s bottom line. Earnings per share were up 11% but that includes a 4% reduction in shares outstanding from significant stock buybacks. Despite the strong top line, cost pressures resulted in only a 7% increase in net income.
Both stocks are down slightly since reporting while the overall market is up slightly.
These two reports seem like a good preview of what to expect going forward as analysts expect only a 1% increase in earnings for the S&P 500 overall. Exclude Apple and estimates drop to -2%.
Counting on a stronger second half of the year, analysts are forecasting a 16% increase in 4th quarter earnings. This is expected to be accomplished primarily by an expansion in profit margins (“Wall Street Is Keeping Its Hopes Alive”
, Ahead Of The Tape, The Wall Street Journal
, April 2, C1). The inflationary pressures evident in FedEx and Nike’s earnings reports suggest that this is unlikely to occur.
It is also important to keep in mind that while the ECB’s two Long Term Repurchasing Operations (LTROs) – which pushed more than €1 trillion into the European banking system – succeeded in stabilizing their sovereign bond markets the last few months, Europe’s problems have not gone away (see my “The Bear Market of 2012”
, originally sent November 21, 2011). One indication of this is the divergence in performance between Northern and Southern European stock markets. For example, Germany’s Dax 30 was up 18% in the first quarter but Spain’s Ibex 35 was down 6.5%.
While the lemmings on Wall Street keep pushing the market up day after day, the facts make clear that the day of reckoning nears.
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