News of the economy’s slowdown continues to roll in, with this morning’s report on durable goods orders delivering the latest excuse to embrace gloom.
New orders for manufactured durable goods fell 2.4 percent last month, the U.S. Census Bureau announced. Coming along with yesterday’s report that existing home sales continued to slide, it’s getting easier to assume that something more than a pause that refreshes has arrived.
Durable goods are a volatile series, of course, and its relevance is one that’s limited to long-term trends. On that note, it’s worth noting that durable goods orders were still higher last month compared with 12 months previous. Nonetheless, Wall Street now seems inclined to see the glass half empty, and any explanation to the contrary is apt to be dismissed.
The aura that trouble lies ahead for the economy is starting to take root in the stock market. The S&P 500 shed nearly a half-percent yesterday, and it’s likely that yesterday’s news of falling home sales in July had more than a little influence. Equity investors previously had been inclined to buy in the wake of the Fed’s hold-’em-steady decision on interest rates on August 8. But the market is coming to realize that if the Fed’s not hiking the price of money, that implies that economic growth may be waning.
Waning, perhaps, but earnings growth remains intact…so far. According to Zacks, S&P 500 median earnings per share growth for the second quarter is a strong 13.2%, based on reporting by nearly 94% of companies in the index, noted Dirk Van Dijk on Monday. What’s more, the positive surprises on earnings far outweighed the negative ones.
Ah-ha, you say, the second quarter is gone; on to the third. Indeed, although for the moment the consensus outlook on earnings calls for a slowdown of only marginal proportions amounting to a 9.4% rise, Van Dijk reported. That’s slower than the third quarter’s pace, but not exactly the end of the world. In fact, 9.4% looks pretty good by historical standards, assuming it proves accurate. And while we’re indulging in prophesy, the median analyst prediction calls for an 11.5% rise in earnings for all of 2006.
Elsewhere at Zacks, Charles Rotblut today advised that analysts overall aren’t forecasting a recession. “I analyzed the projected earnings growth rates for more than 2,300 companies for the next four quarters and numbers were bullish,” he wrote. “Profits are projected to rise by an average of 18.6% in the third-quarter and 22.4% in the fourth quarter. Next year, earnings growth is expected to average 21.8% and 20.6% in the first and second quarter, respectively. By means of comparison, these companies averaged 17.4% growth last quarter.”
The notion of a “soft landing” it seems is alive and well. And it’s hardly just Zacks. The odds of a recession in 2007 are a mere 15%, opined Richard Hoey, Dreyfus chief economist and chief investment strategist in a research note earlier this week.
Donald Luskin, chief investment officer at Macrolytics tends to agree. In a research note today, Luskin explained that “we expect continued robust earnings growth, a view affirmed by the bottom-up Wall Street forward earnings consensus….This forward-looking view on the macroeconomy sees no sign of a slowdown whatsoever.”
But not everyone takes confidence that the past will continue to be prologue for earnings, and by extension, the economy. Although optimism reigns supreme this month for predicting corporate earnings growth, the bloom is set to come off the proverbial rose, warned a report from BCA Research published yesterday. “The recent uptick in global earnings revisions is unsustainable given the developing slowdown in world economic growth,” the consultancy wrote. The smoking gun is the “continuing weakness in our 23-country Leading Economic Indicator.”
So it goes in the land of predicting. But the devil’s in the details, and with a turning point in the cycle upon us, it’s wise to err on the side of prudence for crafting portfolios. The future is always unknown, and when cycles shift, surprises can pop up like weeds.
For now, a big and risk-laden assumption for many is that a slowdown is coming, and that it will, to paraphrase Fed Chairman Bernanke’s recent commentary, take the edge off the inflationary momentum of late. Both equity and fixed-income investors are hoping for no less, and many are investing as if that’s a done deal.
If such hopes find confirmation in the data, the consecration of Bernanke into church of central banking will proceed apace. We too would like to believe that the economy can slow and reduce the core rate of inflation along with it. Perfection is always preferable to the alternative. Unfortunately, perfection is all too rare in the world of economics, and so alternative outcomes must be considered, if only to pass the time.
That notion was on our minds when we read an op-ed piece in today’s Wall Street Journal (subscription required) by Arthur Laffer, who wrote, “You’d have to dig pretty far down in the duffle bag of economists to find one who actually believes in the Philips Curve — the idea that rapid growth causes inflation. In truth, rapid growth in conjunction with restrained monetary base growth is a surefire prescription for stable low inflation.”
In other words, it’s all about money supply (still).