The market is up roughly 2% through the end of Thursday, August 5th, with most of the week’s gains coming from Monday’s gain of 2.2%. Surprisingly, the increase was led by the Energy sector with a 4.3% gain likely based on news that BP plc (NYSE: BP) capped the oil spill in the Gulf. Drillers performed well, specifically, Diamond Offshore Drilling (NYSE: DO) who was up 12% from last week, a phenomenal increase. European banks also released good news on Monday, specifically, HSBC Holdings (NYSE: HBC) and BNP Paribas, who reported better-than-expected earnings. This news gives investors further indication that the European Union banks were able to pass the stress tests from a few weeks ago. Only seven out of 91 banks failed, demonstrating renewed strength in the European banking system.
This week, we are reaching the end of earnings season, so market activity is slowing down a little now that we have earnings reports from about 80% of the S&P 500 companies. Revenue growth has been lower than what we and the markets would have preferred. The average surprise growth in earnings above estimates has been near 11%, with 78.9% of companies beating analysts’ expectations. However, revenue is still struggling at the top line with only a 9% growth in revenue compared to an average reported 50% growth in earnings. While 60% of companies have beat expectations in sales, the average surprise has been a miss of 1.4%, meaning those who are missing sales expectations have missed far worse than those who have beaten sales expectations. Sales are as—if not more—important than earnings in order to have sustainable long-term growth. We expect revenue to be down, as many of the economic releases have shown that while industrial production is up, employees are not being added. Companies have been operating leaner, doing more with less.
Emerson Electric (NYSE: EMR) reported profits soared 51% based on strong U.S. and European sales, but their overall sales increase was still lacking at 11%. Procter & Gamble (NYSE: PG) struggled, reporting diluted net earnings per share because they experienced price cutting and higher marketing expenses. Profits were also down 10%, which resulted in management providing a cautious outlook and announcing earnings may fall below expectations. Unfortunately, this took a toll on the stock in the market, with shares down nearly 3% on the news.
In economic news, the Institute for Supply Management’s Manufacturing Index continued to indicate expansion in the Manufacturing sector, albeit at a bit slower rate. The good news is that the deceleration in manufacturing is being handed off to the Services sector, with the ISM Services Index rising to 54.3 relative to June’s report of 53.8—good news, considering services make up 80% of our economy.
Payroll processing firm Automatic Data Processing (NYSE: ADP) reported Wednesday that the private labor market added 42,000 jobs, predominantly in the small- and mid-sized businesses. Friday’s Labor Department Jobs Report showed a loss of 131,000 in non-farm payrolls, which we still attribute to the laying off of census workers. The jobless rate—calculated using a separate household survey—held steady at 9.5% in July, despite expectations that it would edge higher.
The question remains as to when we can expect larger companies to begin hiring. As we have said, many companies have been operating leaner, using up capacity and inventory. They can only work lean for so long before they will have to hire. Ultimately, the hiring of employees is what will signal the growth to bring the economy out of a recession.
We still believe that the uncertainty that has been weighing on the market is political. The market does not know what to expect in the November elections. There is also speculation that Speaker of the House Nancy Pelosi (D-Calif.) will call Congress back into session early to focus on a jobs bill that the Senate passed earlier in the week. The measure would give states $10 billion for education programs and $16 billion to help cover Medicaid budgets in the first six months of next year. Additionally, the markets are unsure if there will be the expected increase in taxes next year. Uncertainty will almost always cause the markets to bounce around, with every bit of news affecting it in some way.
Furthermore, just when we did not think interest rates could get lower, we saw yields on fixed income investments fall. The three-, five- and seven-year rates fell about 0.08%, giving investors less incentive to save.
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