No matter who is president, jitters will persist

Oct 28, 2012 @ 12:01 am

By Jeff Benjamin

The presidential election is only eight days away, but don't expect the knowledge of who will inhabit the White House for the next four years to cure a bad case of market jitters that has infected the stock market.

That is because the culprits — lackluster earnings, and lower revenue and profit forecasts — are expected to linger for a while.

In the last seven trading days, the S&P 500 has lost 3.4% of its value.

Although still up 12.3% from the start of the year, the index has fallen short on three attempts to test new highs since the Sept. 14 peak. And after each try, the declines have gotten deeper.

“The market volatility we're seeing has been driven primarily by corporate earnings, which have been disappointing pretty much across the board,” said Byron Green, chief investment officer of Green Investment Management Inc.

Even more troubling is a decline in top-line growth, which indicates a weakening economy.

Sixty-nine percent of the 188 companies in the S&P 500 that reported third-quarter earnings through Oct. 24 posted earnings above the mean estimate, but only 38% had sales above the mean estimate, according to FactSet Research Systems Inc. That percentage is the lowest level since the first quarter of 2009, when 36% of companies in the index beat revenue estimates.

When Wall Street sees such a pattern of shrinking top-line growth, it instinctively draws conclusions about a slowdown in future earnings.

“We need to see top-line growth, and we're not seeing it, because the economy is at a standstill,” said Christian Hviid, founder and managing principal of Point Guard Capital LLC.

“The market always looks forward, and so far, the guidance from companies has been more negative than positive, which adds fuel to the fire,” he said. “At this point, it looks like the technicals have broken down and the fundamentals have fallen.”

One example of the growing skepticism is found in the shrinking fourth-quarter earnings outlook.

The latest analysts' consensus has the S&P 500's fourth-quarter earnings beating the comparable period in 2011 by 8.4%, compared with an estimate of 9.6% on Oct. 1 and 14.4% on July 2.

“The presidential election, Europe and the fiscal cliff are all part of the uncertainty in the markets, but the more immediate concern is whether you might be paying too much for corporate earnings,” said Quincy Krosby, a market strategist at Prudential Financial Inc.

“When you look at the market activity, it is clear the concern, in terms of earnings, is about the slowdown in top-line growth,” she said. “We're seeing a slowdown in demand from the earnings reports of the megacap companies, which are the global leaders.”

As third-quarter corporate earnings reports roll in, some “positive surprises” could still help the market, Ms. Krosby said.

The next shoe to drop will be the Nov. 6 presidential election, which some polls call a statistical dead heat.

As usual, the markets are more concerned with certainty than the ultimate outcome.

“One of the key issues is getting the presidential election behind us to help provide the markets with some clarity, regardless of winner,” Mr. Green said.

As soon as the election is over, all eyes are expected to be riveted on the fiscal cliff, with its potential to push the U.S. economy into an immediate recession.

Mr. Russell said companies are already taking pre-emptive action on the assumption that Congress may not act quickly enough.

“There is very little hiring going on, capital expenditures are low and inventories are being taken down,” he said. “Those things are all happening ahead of the fiscal cliff.”

Theodore Feight, owner of Creative Financial Design, said he is waiting for the election results to introduce a fiscal-cliff strategy.

“We told our clients that if Obama gets re-elected, we may tighten our stop-loss orders,” he said. “We're afraid that if they let the new taxes go into effect, it's going to create a recession within six months.”

Brian Frank, owner of Frank Capital Partners LLC, feels some market activity might involve strategic tax management.

“With higher tax rates coming, you might be seeing some corporate executives start to think about completing a deal before the end of the year, in addition to thinking about their own tax bill,” he said.

jbenjamin@investmentnews.com Twitter: @jeff_benjamin

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