FINANCIAL REVIEW

A Solid Week in a Rocky Month

Sinclair Noe — October 24, 2014

Podcast: Play in new window | Download (Duration: 13:15 — 6.1MB)

DOW + 127 = 16,805
SPX + 13 = 1964
NAS + 30 = 4483
10 YR YLD – .01 = 2.27%
OIL – .80 = 81.29
GOLD – .90 = 1232.00
SILV + .01 = 17.31

Last Friday we covered some technical analysis of the equity markets, looking at support and resistance, as well as a short-term bullish pattern, a morning star that had formed. Sure enough, this week provided the follow through on that bullish pattern. Major indices snapped a 4-week string of losses. For the week, the Dow gained 425 points, or 2.5%. The S&P gained 78 points, or 4.1%. And the weekly gain for the Nasdaq was 225 points or 5.2%.

So, where do the markets go from here? The pullback that started September 19th never really materialized into a full blown correction, and there is a feeling that there should be more to the downside, but as of today the markets seem to be firmly in retracement mode. Better to let the market tell you when that retracement ends than to try to impose your opinions on the market. And then remember that we are almost through the treacherous month of October.

The Stock Traders’ Almanac reminds us that “in 64 years before 2014, DJIA and S&P 500 have both declined 26 times in October. However, these October declines were followed by 23 DJIA November-December gains averaging 4.0%. S&P 500 November-December gains have occurred 21 times with a slightly softer average advance of 3.4%. So despite all of October’s horrors, the market has historically finished out the year with a rally far more frequently than not.” A rocky October tends to be followed by solid performance. Again, with the caveat that these are probabilities, not guarantees.

According to Thomson Reuters data through Friday morning, of 205 companies in the S&P 500 that have reported earnings, 69.8% have topped analyst’s expectations, above the 63% rate since 1994 and the 67% rate for the past four quarters. On the revenue side, 59.8% have beaten expectations, slightly below the 61% rate since 2002 but above the 58% rate for the past four quarters. Bloomberg reports that 80% of S&P 500 companies that have released results this season beat profit projections, while 61% surpassed revenue estimates. I think that this means that earnings are so manipulated and analysts’ estimates are a hot mess of smoke and mirrors.

To recap some of the big earnings news this week, Amazon, IBM, and McDonald’s were among the bigger disappointments; Apple, Microsoft, Caterpillar, and 3M were among the bigger earnings winners.

Today’s earnings reports included Procter & Gamble which reported fiscal first-quarter earnings excluding items of $1.07 per share, up from $1.04 a share in the year-earlier period. Revenue slipped to $20.7 billion from roughly $21.2 billion a year ago, missing estimates. P&G announced it will split off its Duracell battery business into a separate company.

UPS reported earnings of $1.32 per share on revenue of $14.2 billion, compared to year ago earnings per share of $1.16 on revenue of $13.5 billion. Earnings and revenue were slightly better than estimates. UPS is having a hard time keeping up with demand. UPS actually ships a lot of packages by rail, and they says major railroads have been struggling to meet demand because the economy is growing, oil is being shipped by rail, and a record harvest means more food is being shipped by rail. Last year a last-minute surge in online consumer promotions left an estimated 2 million express packages stranded on Christmas Eve. And so this year, if they have a similar last minute surge, they say they will charge a premium, or might even refuse to deliver. So much for loving logistics.

Bristol Meyers Squibb reporting earnings of $721 million in the 2014 third quarter, or 43 cents per share, compared with $692 million, or 42 cents per share, in the same period a year ago.

Ford Motor posted third quarter profit of $1.2 billion before taxes, down $1.4 billion compared with a year ago. Net income was $835 million, a decrease of $437 million compared with a year ago. Excluding one-time costs, (also known as the cost of doing business) Ford’s earnings were 24 cents a share, beating estimates of 19 cents. The future for Ford will be riding on the redesigned aluminum body F-150 truck, which will hit showrooms in December.

Several companies that have reported are saying that the strong dollar has hurt results. Amazon, Apple, IBM, McDonald’s, Ford, and P&G all say the stronger dollar hurt results. 3M said earnings were reduced by 2 cents per share. Ford said the dollar cut pre-tax profit by $166 million. IBM said it wasn’t really hurt by the dollar in the third quarter because it hedged, but the hedge is expiring and they will feel the pinch in the fourth quarter. The Dollar Index has been in a strong uptrend since May, finishing this week at 85.79. In July, August and September, the Dollar Index was on a parabolic rise. It now looks like we’re seeing some consolidation in October, with the uptrend still in place.

Sales of new single-family homes rose to a six-year high in September, but August new home sales numbers were revised quite a bit lower, and so it looks like a possible bump in the data. The Commerce Department said sales increased 0.2% to a seasonally adjusted annual rate of 467,000 units, the highest reading since July 2008. Compared to September last year, sales were up 17%. August’s sales rate was revised down to 466,000 units from 504,000 units. The median new home price fell 4.0% to $259,000 from a year ago.

The Labor Department reports seasonally adjusted median weekly earnings were $797 in the third quarter, up more than 2% from a year earlier. That’s a speedier pace than annual growth of less than 1% in the second quarter. This is a measure of full-time workers’ wages and salaries. However, once inflation is factored in, weekly earnings, measured in 1982-1984 dollars, reached $335 in the third quarter, just equaling this barometer of pay in the first quarter of 2008. Which is another way of saying that most people are earning less today than they were 6-1/2 years ago.

Federal prosecutors are investigating Japanese auto parts maker Takata for misleading regulators about the number of defective air bags it sold automakers, including Toyota and Honda. Earlier this week the National Highway Traffic Safety Administration announced a recall of about 4.7 million cars, then expanded the recall to 7.8 million. The Center for Auto Safety has written to federal regulators demanding a criminal investigation into whether Honda properly report the deaths that occurred in its cars. Now a Congressional committee will begin an investigation because everybody is starting to figure out that it is bad when an airbag explodes and sprays shrapnel at drivers. Who knew?

A 10-year veteran Internal Revenue Service (IRS) attorney has sent a letter to Treasury Secretary Jack Lew demanding a congressional audit of the IRS to investigate the agency’s role in allowing US corporations to illegally avoid paying billions of dollars in taxes even as it cracks down on individuals and small businesses. The whistleblower alleges that senior IRS officials have “intentionally undermined the authority of the IRS Whistleblower Office.” Not only that, but the agency has avoided taking action “in cases involving billions in corporate taxes due.” Laws are not applied to large corporations, she writes, but are applied with “draconian strictness to small business, the self-employed, and wage-earning individuals.”

In one case, the IRS was auditing a US company that fraudulently underreported its profits by nearly $3 billion annually. On behalf of the IRS, the whistle-blower had drafted a detailed report proving the fraud, but the agency “closed its audit without ever asking a question or reviewing the documents submitted.” As much as $4 billion in taxes were lost.

In another instance, “a solid case” involving $6 billion in taxes due was “inexplicably shut down,” according to IRS criminal investigation agents. Instead, detailed evidence of fraud and malfeasance “in hundreds to thousands of specific accounts” was ignored. The agent blamed links between senior IRS executives and outside corporations associated with the case.

In the third case, $3 billion in taxes were uncollected and now accumulate year after year. The US company claimed to the IRS that it earns all profits outside the United States, which are then invested overseas, while informing foreign jurisdictions that it earns nothing outside the United States. Although US laws tax Americans “on worldwide income,” the IRS simply closed the investigation despite clear evidence of taxable income.

The IRS Whistleblower Office was created by Congress in 2006 to encourage leaks of evidence concerning large-scale corporate tax fraud. According to the IRS itself, the United States loses $450 billion a year due to tax evasion. But the actual sum is probably much higher. Sounds like excessive lobbyist influence or a revolving door between the regulators and the regulated.

Of course the headline story today was that a doctor who had worked with Ebola patients in Africa, returned to his home in New York City and he has now tested positive for Ebola. I read a serious financial analyst who said that the spread of the disease could limit economic growth, and he thought that might have held back stocks today from bigger gains. Certainly, Ebola has the potential to create all sorts of problems, but so far damage has been very limited in the US: one death, which is one too many; but compare that to the two students killed at a high school in Seattle today, or the 4 deaths from exploding Takata airbags, or the 29 deaths and multiple injuries associated with the GM faulty ignition switch recall. In the past week about 700 people died in auto accidents, 602 fell down and never got up; 1,620 died of complications from diabetes; 13,140 died from heart disease; and 3490 died from lung cancer in the past week. And somehow the stock market was up on the week.

We finish with the “Irony of the Week”, and while there were many strange and ironic happenings this week, the winner is Reynolds American. The cigarette company has informed employees that beginning in next year, they will no longer be able to smoke indoors at corporate offices and buildings.

And what about next week? Well, the Federal Reserve FOMC will meet to determine monetary policy, so that should be entertaining.