Today's rally in stock prices is attributed to relief over China's GDP growth and earnings reported by JP Morgan and Wells-Fargo.
Though the largest bank stocks are admittedly depressed, I still regard them as speculative, given the opacity of financial statements for the largest financial firms. I have broader concerns about earnings as well.
Consensus earnings estimates for the current quarter are for flat earnings on the S & P 500. Though consensus earnings estimates have fallen in recent months, making positive surprises more likely than before, I am concerned that estimates for the third and fourth quarters this year are too high. Estimates for the fourth quarter are for a double-digit increase in earnings compared to the previous year.
For years the decline in the foreign-exchange value of the U.S. dollar provided a lift to reported earnings by U.S. multinational companies, as revenues and earnings from overseas operations were translated into more U.S. dollars (as a result of the rise in foreign currencies versus the U.S. dollar).
But with the strength of the dollar over the past year versus the Euro in particular and against many emerging market currencies, foreign results of U.S. companies are being translated into fewer U.S. dollars given the declines in foreign currencies versus the dollar.
Not only has the European debt crisis led to sluggish economic conditions overall and recessions in several countries, the Euro has fallen significantly in value against the U.S. dollar. The Euro has fallen 14% against the dollar over the past twelve months.
Today two companies--Ford and Lexmark--announced that their European revenues declined by double-digits in the latest quarter compared to a year ago. Other companies, including Procter and Gamble, have recently noted the drag on profits caused by their European operations.
This risk of earnings disappointments supports my existing preference for holding considerable cash reserves in addition to significant stock holdings. Though cash yields almost nothing in the short-term, its value rises dramatically when stock prices fall sharply.