A Natural Time for Stocks to Object to their Own Valuations

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Earnings season has begun on Wall Street and it’s nearly as miserable as the gale blowing through St. Kilda on a grey and British-like Monday morning. The Dow Jones fell a neat and tidy 100 points on Friday and most of the major indices fell by at least one percent. Finance and tech – in the form of JP Morgan and Intel – were the two big earnings disappointers.

On Friday we argued there would be more. Q1 and Q2 earnings looked good in 2009 compared to the free-fall quarters of 2008. But that improvement has run out of stimulus and momentum. The U.S. labour market still stucks, to use a scientific term. And stocks are beginning to express their doubts.

It would be a natural time for stocks to object to their own valuations. U.S. investors were sitting on a 62% rally in stocks since the March lows of 2009. Hmm. That sounds vaguely like a 61% Fibonacci retracement. This leads us to the obvious question: is the March 2009 rally topped out?

Well you know what we think since we wrote it last week. More earnings results from IBM, Citigroup, Bank of America, Morgan Stanley, and Starbucks could confirm that reversal this week. Or not. We will just have to see.

Not that the power of U.S. earnings reports compels Australian stocks to follow the U.S. lead. It’s a different market here, with different business conditions, and closer trading ties to China. But how will corporate earnings travel this year? It may not matter, honestly, given that P/E ratios are already so high.

On a totally different subject, the spot iron ore price is on the up and up. The spot price, according to Metals Bulletin, is around $135 a ton, which is a lot higher than the annual contract price of $61 per tonne. Some analysts are already calling for a 30-50% rise in the 2010 contract price.

If it happened, that would obviously be a big boost to earnings for the iron ore majors. But enough to justify current valuations? The more speculative play would be the juniors, although those too have already had a pretty good run since March.

Besides, Bloomberg reports that the Brazilian ore giant Vale is grabbing market share from Rio Tinto and BHP Billiton. Bloomberg says Chinese steel production is driving ore demand to a record 1 billion tonnes this year. Vale claims it can expand production faster than its Aussie rivals, and is set to grab 28% of the ore market.

Cheers to Saul Eslake for his civil and thoughtful reply to our criticism of his article on debt last week. A reader alerted us to his comment at the website. We’ll have a closer look and a reply tomorrow.

Another reader writes in that it’s nothing like 2007, as we suggested on Friday. The 2007 crash wasn’t preceded by any signs or evidence of a correction. Today, on the other hand, we have two solid years of mediocrity from which share prices, or at least earnings, can possibly recover.

Possibly. But as we’ve been saying all along, in a credit depression, corporate cash flows will revert to historic means. There will be fewer profits in the economy as economic activity adjusts to lower levels of credit and loan growth.

That doesn’t mean there aren’t good businesses with growing profits to invest in. But you probably won’t find them in the finance, technology, insurance, and media sectors like you could over the last twenty years. You’ll have to do more research and take more risk. The good news is that this will cause more and more investors to give up on stocks as an asset class. When no one wants them, then you’ll have a real buy signal.

Until then, we creep along in this petty pace from day to day. A great Money Migration is underway. And this could be the year it leads to a serious strain in the finances of the Western Welfare States. You’ll want to own fewer stocks, more cash, and more gold in preparation.

An outlier? How about a Republican winning a Senate seat in Massachusetts? We have no recollection of the last time a Republican actually won a Senate seat in that state. There’ve been some close races in the past. But it looks like State Senator Scott Brown is giving Democratic attorney general Martha Coakely all she can handle and more.

CNBC ring-master Jim Cramer says a Brown win on Tuesday will trigger a huge rally. Cramer says investors will celebrate the “Pelosi Politburo Emasculation.” He’s referring to Nancy Pelosi, the female Speaker of the House of Representatives from the People’s Republik of California. Cramer reckons a repudiation of Coakley is the high red-tide mark in America’s “spread-the-wealth” Federal policy.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. Coakely is a seriously bad candidate, and that about sums it up.

    Reply

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