Earnings estimates are suffering from a bout of weakness these days, writes Michael Krause of AltaVista Independent Research, a New York consultancy that specializes in fundamental analysis of exchange traded funds, or ETFs. In a newly minted report, Krause observes that for 2006 forecasts “we are seeing sustained and accelerating revisions to the downside. Over the past month, 2006 estimates for seven out of nine sectors declined….” He adds that the slide is “the fastest rate of decline since we began monitoring 2006 estimates back in July 2005.”
Krause’s report comes at an anxious moment, given all the debate about whether the economy is, or isn’t poised for a stumble. Indeed, the mixed signals emanating from recent economic releases has Wall Street abuzz about what comes next for the stock market. In search of clues, we interviewed Krause via email….
In your latest research report, you write that “we are seeing sustained and accelerating revisions to the downside.” Give us an overview of what’s going on. Is the earnings cycle finally turning?
We still expect that S&P 500 earnings will increase this year. What’s different is that expectations are now on the decline, whereas for the past two years estimate revisions were almost universally positive, even excluding the effect of Energy earnings on the S&P, which everyone recognizes played a big part.
The accompanying graph (see below) illustrates the trend in 2006 earnings estimates since July of last year. Estimates for the S&P 500 as a whole rose through November and then started to decline. But excluding Energy, estimates that had remained stable through last summer began to weaken in the fall and have started to decline at a faster rate more recently.

Historically, trends in estimates revisions tend to persist for some time. That is, they don’t haphazardly move up/down from month to month, so the downward trend, now established, could well continue. After two years of being behind the ball on the strength of corporate earnings, Wall Street analysts might now be too optimistic at a time when earnings growth is quite naturally slowing in this, the fifth year of a profit recovery.
However, the fact that Wall Street gets its numbers wrong need not spell doom for the market. Even if negative estimates revisions were to continue apace, S&P 500 earnings would likely end the year up around 6%. That’s not as high as the 11.4% suggested by current consensus estimates, but still in-line with the post-WWII average of 6.2%.

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Thirty years is a long time, but is it too long for comfort these days? The folks at Treasury think not, or at least that’s the implied message that will come packaged in the revived 30-year bond, which debuts anew on Thursday.
In August 2001, when we last glimpsed the government issuing new debt with a life span of three decades, the world looked a bit different. For starters, the tragedy of 9.11 was still a concept in a few twisted minds, and so a bit of innocence (or gullibility?) still defined the investment psyche on conjuring the risk factors that could arise on a moment’s notice. Meanwhile, inflation in August 2001 was running at a relatively mild 2.7% annual rate, based on the government’s consumer price index.
In February 2006, fewer investors harbor illusions about the risks that potentially lurk in the foreseeable future. Those risks can cut either for or against the fortunes of bond values, which is to say that winds of inflation or perhaps disinflation could blow harder at a moemnt’s notice. The former, however, seems to have the upper hand at the moment.
Indeed, inflation (the only potential threat to an otherwise “safe” government bond) is a bit higher now than when the 30-year bond last made an appearance. Consumer prices are rising by 3.4%, according to the annualized rate posted in December. Inflation’s pace, in other words, is roughly one-quarter more than it was when the Treasury last sold its paper embedded with 30-year maturities.

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Today’s employment report for January strikes yet another blow at the forces of pessimism emboldened by last week’s surprisingly weak fourth quarter economic news. Indeed, this week’s news on the economy has been generally upbeat, offering a sharp counterpoint to last Friday’s disappointing GDP release. But there’s a catch: the encouraging update on the employment front comes at an anxious time for inflation expectations, which are on the rise, or so the ongoing bull market in gold suggests.
Sticking with jobs for the moment, it’s a bit easier to be cheery about growth this morning. The Labor Department advises that the jobless rate last month fell to 4.7%, the lowest since July 2001. The economy created 193,000 new jobs in January, up from December’s relatively sluggish pace of 140,000. Although November’s revised sizzling pace of a 354,000 gain seems a world away, it’s nonetheless clear that the American economy’s ability to mint new employment opportunities is far from dead in 2006. Indeed, last month marks the 29th straight month of growth in new jobs. The previous stretch of unbroken gains was the 33 months through May 2000 (the run would have been 52 months had it not been for August 1997’s mild stumble, but we digress).

Adding to potency of January’s employment momentum is the fact that the rise was broadly dispersed. Even the perennially job-challenged manufacturing sector managed to eke out a gain of 7,000 new jobs last month. Only retail trade and government posted losses, albeit relatively slight ones at that.

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It’s too early to say what trend will define the Bernanke era of central banking, but the bull market in gold may get a footnote or two once the final history is written. Indeed, the precious metal is soaring, suggesting that something less than unwavering faith prevails when assessing the odds of success among mortal beings charged with defending the integrity of paper currencies.
As of yesterday’s close, gold has climbed 10% so far in 2006. Catalysts driving the metal higher come in two basic flavors: geopolitical and economic. The obvious suspects in the former include rising anxiety over any number of Middle East tensions (Iran’s nuclear program, Hamas’ election in Palestine, the ongoing terrorism in Iraq, etc.) The economic worries start with the red ink that defines America’s budget and trade ledgers, and move on to the ongoing elevation in the price of oil, which some say portends higher inflation.

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On the first day of the newly minted Bernanke era, the pressing question is whether the economy’s slowing, and if so, is it slowing more than a little?
The topic returned to the limelight last week when the first estimate of the nation’s gross domestic product surprised with a sharply lower rate of growth than the dismal science was expecting. Optimists quickly responded that something was rotten in the data, and that future revisions of GDP would return the official measure of the economy’s pace to form, namely, robust growth.
Judging by consumer spending of late, the optimists have reason to cheer. As the government reported on Monday, Joe Sixpack and his friends are in no mood to reign in their spendthrift ways. Personal consumption rose a strong 0.9% in December, as it did in November, based on revised numbers. Back-to-back strength, in no uncertain terms. Take that, you pessimists. Underscoring the trend is the fact that durable goods purchases were in the driver’s seat for pushing overall consumption higher in the final two months of 2005.

If a sharp slowdown, or worse, is coming, Joe seems cheerfully oblivious to the threat. As such, one might wonder if a slowdown is probable, or even possible if Joe and his buddies aren’t on board with the idea. Personal consumption spending, after all, represents around 70% of GDP. As goes consumers’ willingness to use the heralded credit card, so goes the economy.

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Alan Greenspan packs up his bags today and says farewell to the job he’s held for the past 18-1/2 years. By several measures, he’s leaving the financial system of the United States in better shape than he found it. The standard inventory of accomplishments on the maestro’s watch includes lower inflation; milder and less frequent recessions; and greater transparency in the business of managing the nation’s money supply.
Call us crazy, but that’s progress by any reasonable definition of enlightened and successful central banking. That said, the maestro’s hardly escaped criticism. Whether it’s the rising trade gap, the march of red ink on the government’s balance sheet, or consumer spending run amuck (by some accounts), critics find much to question. The Fed, of course, has a fairly limited mandate, and relatively few tools at its disposal. As such, we can argue about what exactly is, and isn’t, relevant for assessing a Fed chairman’s record. But this much is clear: Greenspan leaves his successor, Ben Bernanke, with a thicket of rising challenges for which there are no obvious or easy answers in the deployment of the traditional levers of central banking.
For all the triumph that surrounds the retelling of Greenspan’s tenure over the past generation, it’s less than clear that the Fed and its counterparts around the world will be as successful in managing what awaits. The challenge is compounded by the fact that the world is arguably too dependent on the American consumer, an economic force that will be increasingly threatened by its penchant for assuming ever greater piles of debt. Adding to the uncertainty is the fact that Greenspan leaves his replacement with no obvious blueprint for running a central bank. The man who today exits the most powerful job in global finance with his reputation intact has become notable for being a nimble steward of monetary management, espousing no central theorem or rules of play.

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The federal government is a large and sprawling beast, spitting out economic reports as routinely as politicians call press conferences. The only difference in the 21st century being that official statistical releases now come a la carte, and in a variety of flavors. Search for a perspective that suits you, and consume only what you want.
Case in point: If you’re feeling gloomy about Friday’s surprisingly weak report on the economy for the fourth quarter, the ever helpful Treasury Secretary John Snow has a few encouraging words to counter the gloom emanating from that other government agency. “The advanced estimate of fourth quarter 2005 GDP released this morning is inconsistent with the underlying strength of the U.S. economy,” he opined in a press release dispatched after the Bureau of Economic Analysis released the advance estimate of GDP for last year’s October-through-December period.
Not only does Secretary Snow find reason to question BEA’s fourth-quarter analysis, he suggests that an informed observer might do well by looking elsewhere for economic enlightenment. “I would not read too much into today’s numbers,” he counsels. “They are somewhat anomalous, reflecting some special factors.” (Is that Treasury-speak for the BEA goofed?)

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No matter how you spin it, a drop to 1% from 4% is something more than trivial.
The big question now is whether the advance estimate of 1.1% growth for the economy in the fourth quarter portends a recession or merely a slowdown in 2006. Some pundits continue to think that neither is coming. Then again, weren’t we warned recently of darker days ahead via the inverted yield curves?

In any case, there are the numbers to digest; taken at face value, they paint a troubling profile. GDP rose at the slowest pace in three years in the last three months of 2005, the Bureau of Economic Analysis reports. Digging deeper, the stats only get worse, starting with the massive 17.5% fall in durable goods purchases in the fourth quarter–the biggest decline in 18 years. And while consumer purchases kept rising during October through December, they did so at a slim 1.1% pace, or the slowest rate of ascent since the last recession in the second quarter of 2001.

To say that economists were surprised by the GDP report is something of an understatement. The consensus forecast called for a 2.8% rise. The fact that the actual number came in at only 1.1% tells of the vast disconnect between expectations and reality.
The question is whether the advance GDP report constitutes reality, a line of inquiry that’s found much attention today in the wake of the economic news. Knowing full well that each and every GDP report is revised, some are holding out the hope that today’s 1.1% fourth-quarter rise will evolve into something more encouraging when the government dispenses the so-called preliminary report and then the final one.

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The general assumption regarding the current Fed policy is that the central bank’s intent on cooling the housing boom. Until and if the real estate market cries “uncle,” the central bank will continue raising interest rates. At least that’s the theory, and as theories go it’s as good as any, which is to say it’s in play until proven irrelevant.
As for facts, the housing market in particular has been on a tear in the 21st century, the fuel being the easy credit that became standard of recent years. Meanwhile, the Fed’s Alan Greenspan has been stung by criticism that the world’s most powerful central bank has been asleep at the switch while two of the greatest speculative booms in history have unfurled beneath its monetary nose.
The first, an extraordinary stock market run in the late-1990s, ended with a bursting of the bubble that for a time looked like it might drag the economy down with it. The Fed barely lifted a finger to slow the rise of excess in the latter half of the nineties, despite the maestro’s infamous recognition of the clear and present danger brewing a la his “irrational exuberance” speech of 1996.
Arguably, there is now another bubble in our presence, this time in residential real estate. But compared to its predecessor, the signs of irrational exuberance are fuzzier, the implications for the economy less distinct. History is clear on what the stock market crashes can do. The deflating of national housing bubbles isn’t nearly as common, nor as deeply studied.
That said, there are signs of late that the housing bubble, if in fact that’s what we’re in, is losing air. Whether the future will bring a slow leak or a crash remains to be seen. For the Fed’s part, it seems fixed on encouraging the former. Yet central banking is a blunt tool, as we’re so often told, and so the best laid plans may yet produce surprises.
In any case, it’s clear that the next five years aren’t likely to look like the past five years when it comes to housing trends. Yesterday’s report on December’s existing home sales is the latest bit of evidence suggesting that cooling is now the operative trend in residential real estate. Last month’s sales fell to the lowest rate since March 2004, dropping a sharp 5.7% in December from the previous month.

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Optimists like to say that there’s always a bull market somewhere. The challenge is deciding where the aphorism applies, and where it doesn’t. As always, there are doubts for each and every asset class. Inevitably, there is hope as well. Beauty and bull markets, in sum, remain in the eye of the beholder. Time is the final arbiter of who’s right and who’s wrong, but waiting ten years is about as practical letting your cat baby-sit the parrot.
Now that we’ve dispensed with the usual caveats, we’re free to point out that commodities, broadly defined, appear to be caught up in a phenomenon that some might label a bull market. In fact, more than a few pundits are applying the term these days, and forecasting that more of the same is on tap. One of the early adopters of this theme has been the celebrated globe trotter/investor Jim Rogers, who jumped on the band wagon early by launching the Rogers Commodity Index in 1998, a contrarian move at the time, given the soaring equity market back then.
In 2006, commodities as an investment look decidedly less contrarian. Indeed, most broad-based commodity indices have done quite nicely in recent years. The Dow Jones-AIG Commodity Index, for instance, gained an annualized 18% a year for the three years through the end of 2005, comfortably above the S&P 500’s 14.4%, for instance. And last year’s performance showed that commodities’ momentum was in particularly strong form, as the chart below reveals.

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