Investors Look to Earnings Season for Stock Market Trend

By: Money_Morning

William Patalon III writes:Earnings season will plug along this week as reports from several banks provide the latest insight into how well the beleaguered financial-services sector is weathering the global credit-crisis storm.

Among the earnings season headlines: Bank of America Corp. ( BAC ) will be issuing its final earnings report of the pre- Countrywide Financial Corp. (CFC) merger era and investors hope that Wachovia Corp. ( WB ) follows in the recent footsteps of Citigroup Inc. ( C ) and JP Morgan's Chase & Co. ( JPM ), the latter two of which both provided better-than-expected (though certainly negative) results.

Yahoo! Inc. ( YHOO ) gives its shareholder a bit more ammunition for the never-ending Microsoft Corp. ( MSFT ) buyout controversy, as Yahoo execs are clearly hoping against hope some decent numbers can save their skin (musings known by the acronym "WWID" - for "What Would Icahn Do?).

Amazon.com Inc. ( AMZN ) will shed some light onto the U.S. consumer spending/retail sector pictures; however, investors should remember that those Internal Revenue Service rebate checks have likely all been spent by now . The U.S. Federal Reserve stays in the limelight as the Beige Book provides the country one more look at the mindset of U.S. policymakers.

The energy-supply data will be analyzed more closely as investors hope that prices are headed down to more manageable levels. And, of course, the Freddie Mac ( FRE )/Fannie Mae ( FNM ) saga merits continued close scrutiny. Anyone interested in some newly issued stock of these financially strapped companies?  [For a related Money Morning story containing the latest developments in the Fannie/Freddie saga, please click here .]

Last week provided investors with a nice reprieve from the daily surge in oil prices, as well as an apparent rebound in the Dow Jones Industrial Average Index - out of bear-market territory. But at least with the stock-price rebound, there's a real question about whether this represents the first leg of a new bull-market uptrend, or is just a bear-market "head fake" that will separate many investors from their money. [For a special weekend market bulletin, in which Money Morning Investment Director Keith Fitz-Gerald argues that last week's reversal in trading trends was such a "head fake," please click here . The report is free of charge.]

The backdrop for such a "bear trap" was just about perfect as the week ended, for the overall investor-market mindset had shed the dire outlook of recent weeks and months. Bad earnings somehow didn't seem so bad.  Negative forecasts somehow didn't seem so negative.  Cautionary comments by the central bank didn't translate automatically and immediately into marketplace fears. Weak economic releases somehow didn't seem so weak.  Investors departed for the weekend with a newfound confidence (or, as we fear, overconfidence). Again, this begs the question: Is this the start of a new, bullish trend, or is it just an aberration that will soon yield to a resumption of downward stock prices and rising food-and-energy costs?

Stay tuned…

Coming up in the week ahead :  Leading Economic Indicators (Today/Monday), Fed Beige Book (Wednesday), Existing Home Sales (Thursday), Durable Goods Orders (Friday), New Home Sales (Friday).

Market Matters

Freddie Mac and Fannie Mae stayed in the headlines last week as U.S. Treasury Secretary Henry Paulson announced plans for a "non-bailout" government bailout , complete with improved borrowing terms and an expanded line of credit (and which required congressional approval, easier said than done). By week's end, Freddie toyed with the idea of "going at it alone" (like any good private enterprise should) and opened discussions about raising capital by offering up to $10 billion in new stock.  Given the company's current "dire" financial position, any new shares must offer great incentives to potential investors.  Currently, Freddie's outstanding preferred stock yields in the neighborhood of 14%.

Meanwhile, the U.S. Securities and Exchange Commission (SEC) emerged from hibernation and offered a few regulatory ideas of its own. With " short interest " at all-time record levels, the SEC initiated actions aimed at limiting investors' abilities to engage in short-selling strategies (which many observers have labeled as the "speculative excesses" that are responsible for everything from soaring energy prices to plummeting stock prices). Not be upstaged, the Federal Deposit Insurance Corp. (FDIC) took possession of IndyMac Bancorp Inc. (OTC: IDMC ), another troubled institution engaged in "risky" mortgage lending, which opened again as a federally-owned institution.  (So who's next and just what will that cost the taxpayers? ) 

Bailouts and new regulations aside, the financial crisis still has a way to go - and possibly a very long way [To read my two-part report from last week about a Japan-style "Lost Decade" for the U.S. economy , including the investments you can make to sidestep this long malaise , please click here. Both reports are free of charge.]

In terms of earnings season, while Wells Fargo & Co. ( WFC ) , JP Morgan Chase , and Citigroup announced weaker earnings (or losses) for the last quarter, their results actually beat Wall Street's expectations.  Merrill Lynch & Co. Inc. ( MER ) helped shore up its capital position by selling its 20% interest in Bloomberg LP for roughly $5 billion.  The world's largest brokerage firm also reported its fourth-straight quarterly loss and was downgraded by Moody's Corp. ( MCO ) immediately after the release.  Outside of financial-services companies, airlines - Continental Airlines Inc. ( CAL ) , Delta Air Lines Inc. ( DAL ) and American Airlines Inc. parent AMR Corp. ( AMR ) - did as expected in this earnings season, and reported massive losses.

Google Inc. ( GOOG ) and Microsoft were among the earnings-season headlines, issuing disappointing forecasts, despite reporting quarters that saw earnings jump by more than 35%.  Oil-services giant Schlumberger Ltd. ( SLB ) reaped the benefits of higher energy prices and manufacturer Honeywell International Inc. ( HON ) raised its forecast for the rest of the year. 

Investors enthusiastically received the positive (yet negative) earnings news from the (depressed) financials and also reacted to a pullback in oil prices.  Early in the week, the dollar dropped to a record low against the euro and oil continued its endless climb.  After that, however, in four consecutive trading sessions, crude plunged by more than $15 a barrel to a market price of less than $130 - its lowest-such close in more than a month.

Excellent supply reports showed that oil-and-gas inventories actually rose last week as demand slowed, given the higher prices.  Mid-week, investors took the opportunity to seek out some bargains as the Dow soared close to 500 points and experienced its best two-day percentage gain since October 2002.  The other indexes lagged (thanks Google), though still ended the week in positive territory.  Bonds tumbled as investors unwound previous flight-to-quality trades.  The week came to a close with plenty of uncertainty, but also with the slightest glimmer of hope out in the market that the financial (and oil) madness may one day come to an end (although we here at Money Morning still believe that "end" is well down the road).

Economically Speaking

News from the economic front was not quite so positive last week as those inflationary fears we've been warning about for more than a year appear to finally be coming to fruition .

The June Producer Price Index (PPI) rose at its fastest pace in 27 years and wholesale prices now stand more than 9% higher than they were at this time last year. Likewise, the Consumer Price Index (CPI) jumped by 1.1% in June as energy prices skyrocketed by more than 6.5% during the month.

For those economists who choose to discount the energy statistics, core CPI experienced its worst showing since January and reflected escalating prices in airline tickets, among other areas. (Since ticket prices are directly tied to the price of jet fuel - a form of "energy price" - shouldn't those optimistic economists factor travel out of the "core" equation as well?)

Retail sales rose by a slower-than-expected 0.1% in June, as weakness in auto sales overshadowed the consumers' desires to spend those government rebate checks.  In fact, many naysayers previously warned not to put too much stock in recent retail statistics as they are more reflective of that (temporary) economic stimulus than they are of any real motivation for consumers to shop. 

U.S. Federal Reserve Chief Ben S. Bernanke was in the spotlight again last week (as he seems to be every week, these days), as he delivered his mid-year testimony to Congress and discussed the Fed's ongoing challenges of stimulating a weak economy without prompting additional inflationary pressures.  The central bank chair continued to walk a fine line between these two crises and the minutes from last month's policymaking Federal Open Market Committee (FOMC) meeting revealed the difficult balance.

While many Fed-watchers expected the next move in rates to be higher, the continued economic weakness makes a rate escalation potentially deadly to the weak economy. For now, the central bank pretty clearly believes that the best move may just be no move at all.  The Fed also announced some new rules aimed at protecting residential homebuyers against the "predatory" practices of those (now defunct) mortgage originators.

These days, lenders actually may be required to verify a potential borrower's income to determine if he or she qualifies for a loan.  (What a shame IndyMac never thought of that before.) 

Weekly Economic Calendar

News and Related Story Links:

• Money Morning Special Market Bulletin: Special Report: Are We Now Running With the Bulls, or Just Following More Bear Tracks?
• Money Morning Special Investment Report: The Lost Decade: How the U.S. Financial Crisis Resembles Japan's Ten Years of Misery - And How to Play it (Part I of II).
• Money Morning Special Investment Report: The Lost Decade: How the U.S. Financial Crisis Resembles Japan's Ten Years of Misery - And How to Play it for Profit (Part II of II) .
• Money Morning Financial Analysis: Inside Wall Street: The Real Reasons the U.S. Banking System Lost its Way .
• Wikipedia: Short Interest .
• Money Morning News Analysis: Escalating Inflation at Home and Abroad Puts Pressure on Central Bankers .

By William Patalon III
Executive Editor

Money Morning/The Money Map Report

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