Earnings Risks Ahead?

Market observers have noted that the challenges in Europe will also affect U.S. multinational companies and their earnings.  I don't know, however, whether analysts have sufficiently factored in reduced European sales by U.S. companies in their earnings estimates.


Oracle gave a hint about what the effects of Europe's struggles might be as it released its quarterly earnings report yesterday.  Though overall the quarterly results exceeded consensus analyst estimates and the stock rose, sales to Europe, Africa, and the Middle East declined 7%.  Overall revenues at the company rose only 1% in the quarter.  One percent revenue growth for a growth company is not impressive, though Oracle is a fine company that is fairly valued.


While the market rebound has been welcome (and probable--note my 5/20 blog with the S & P 500 at 1295), I'd not get too comfortable.  There are superior companies still selling at attractive valuations that should remain core holdings.  But I still think this is more of a "guerrilla warfare" market that requires more of a nimble, trading mindset than a buy-and-hold approach.


Steve Lehman
LehmanInvest.blogspot.com/


S & P 500:  1358

The Return of the Bond Vigilantes

A generation ago, when government budget deficits swelled to troubling levels, elected officials failed to take responsible action to cut spending or increase revenues.  But another group of actors appeared, dubbed the "Bond Vigilantes," to force action.  Participants in the U.S. government bond market sold bonds and drove interest rates higher because of a lack of confidence in elected officials.  This continued to the point where even the elected officials knew they had to act because the borrowing costs for the government were rising sharply.

In the last decade, observers have lamented the disappearance of the Vigilantes, as budget deficits exploded in both the Bush and Obama Administrations, yet interest rates kept falling (not rising).  With interest rates on U.S. Treasury 10-year notes at only 1.6%, the vigilantes have not returned to the U.S.  

But they have returned to Europe, as despite a 100 billion Euro bailout for Spanish banks, yields on Spanish government notes today rose to 7.15%, a dangerous level that preceded collapses in Ireland and Greece.  When confidence goes, whether in a bank or a government, it is hard to keep the situation from spinning out of control.

When the Vigilantes act in unison, their momentum is difficult to reverse.  It will probably require coordinated central bank intervention, along with significant European policy coordination, can stanch the unraveling and lead to higher asset prices.

Steve Lehman

LehmanInvest.Blogspot.com/

Trouble in... Switzerland?

Everyone by now knows that the financial crisis in Europe is worrisome, even if they don't know exactly how it might affect others if Greece drops out of the Euro zone or Spain's banks go bust.


A news item today gives a concrete example.  It is widely known that Greece has been profligate, Spain had a housing bubble even greater than that in the U.S., and Italy has an imprudent level of government debt.


But what about Switzerland?  Why would this matter to Switzerland, which doesn't use the Euro, and which has long been considered one of the safest places in the world to keep one's money.  


Shares of Credit Suisse, one of the two leading Swiss banks, fell 10% today after the Swiss central bank issued a statement that Credit Suisse needed to stop paying dividends to shareholders or else issue more shares to bolster its financial condition because of credit losses.  (The other leading bank, UBS, had to be bailed out by the government in 2008.)  


So when top banks in Switzerland need help, it really is serious.  


At a time like this, it doesn't hurt to own some gold--just in case.


Steve Lehman
LehmanInvest.blogspot.com/


Gold:  $1,625

Dividends

Those with a sense of market history have known for a long time that dividends have been an important part of stock market returns.  Approximately 40% of the long-term return from investing in stocks has come from dividends.  What's more, the highest-yielding quintile has had substantially higher returns than the lowest.


Now in this era of extremely low interest rates and especially with the retirement of the Baby Boomer generation, it seems that everyone has learned the value of dividends.  Dividend-oriented mutual fund have had net inflows for 44 straight weeks.                                                                                                            


Has this gone too far?  Researchers at Merrill Lynch recently found that the highest-yielding shares in the S & P 500 now trade at the biggest premium in at least 20 years versus those with the best dividend growth.


I still think it makes sense to invest in high-yielding stocks (except electric utilities).  I also would allocate a portion of assets to stocks with significant cyclicality, in case the U.S. stock market rallies as I expect.


Steve Lehman
LehmanInvest.blogspot.com/


S & P 500:  1315

Question Authority (ies)

So much has been written about the European financial crisis that I doubt I can contribute anything.  


But I am struck again, as I was with the U.S. housing bubble, by the need to be highly skeptical of the authorities.  Alan Greenspan and Ben Bernanke dismissed concerns about the consequences of the housing bubble in the U.S.--and later of the collapse of Bear Stearns.  


Now in Europe, as concerns have shifted to Spain (after Ireland, Greece, and Portugal), the authorities have similar, dubious credibility.


The Spanish Prime Minister had recently estimated that the capital shortfall of the entire Spanish banking system was no more than $19 billion.  But one bank alone--Bankia--required $24 billion in additional capital.


Developments in Europe do indeed seem to be, as one observer noted, "like a slow-moving train wreck."  But I continue to think that stock market sentiment had become so depressed that a significant rally is likely, especially in the U.S.


Steve Lehman
LehmanInvest.blogspot.com/


S & P 500:  1324

Stocks Versus Bonds

Bonds have been superior investments for some time, particularly on a risk-adjusted basis.  As a result, there has been a torrent of withdrawals by individual investors from equity funds into bond funds.  Stock performance relative to bond performance peaked in 2000 and has been in a declining trend ever since.  With interest rates at historic low levels, might this relative performance reverse?


Dividend yields on stocks now exceed the yield on Government notes, which hadn't happened since the 1950's.  With yields on 10-year U.S. Treasury Notes at only 1.5% versus more than 2% on the S & P 500 stock index, on an income yield basis stocks are as cheap versus bonds as they were in early 2009, before stock prices generally doubled.


Despite bonds being a haven when investors are fearful these days, I suggest beginning to draw down cash and also shift from U.S. government bonds to buy some depressed stocks.


Steve Lehman
LehmanInvest.blogspot.com/


 S & P 500:  1278

International Equity Valuation Update

Foreign stock markets have not been the place to be over the past year.  Developed and emerging markets have been weak, and the strength in the U.S. dollar has made losses to U.S. investors overseas even greater.  So how do foreign valuations look now?


The weakness in emerging stock markets has left them historically undervalued.  On a dividend yield basis, markets are two standard deviations below historic valuations.  But relative to developed markets, emerging market equities are only at fair value.


As might be expected, European equities are quite undervalued (on a book value and on a dividend yield basis), but valuations are still far from the extremely depressed levels of early 2009.


At this point, I'd begin buying European equities and would have only a token holding of emerging markets.  Emerging market governments will likely reduce interest rates to stimulate economic growth, and the resulting currency weakness would be a headwind amidst global economic weakness.


Steve Lehman
LehmanInvest.blogspot.com/