I Will Take That EPS Beat With A Shaker Of Salt Please
Is that what we have come down to? Earnings beats based on simple fraud? In some cases, Rosenberg claims, that may well be the case.
Everywhere you look these days you can’t help but find a reference as to how nearly 80% of S&P 500 companies have managed to surpass their earnings estimates and the current edition of Barron’s added that they “have beaten estimates by a staggering 11%, near the highest on record.” This, of course, is a reason to be bullish on the equity market.
But page B1 of the weekend WSJ exposes these earnings “beats” for what they are — fraudulent, for lack of a more appropriate term — see For Some Firms, a Case of ‘Quadrophobia’. A just-published study covering nearly 500,000 corporate results over 27 years found how companies “round up” their numbers to beat their estimates fractionally knowing that the fast-money momentum players will trade the stock price higher. On average, it only takes $31,000 in quarterly net income to beat estimates by a penny, which can be handled easily by a tweak to inventory valuation. The report also showed that companies that find ways to “round up” are also the ones with the highest propensity for re-statements in the future. Well worth a read and hopefully ends the nonsense that we see in the media and Wall Street reports over the extent to which financial results are meeting or beating pre-conceived EPS projections.
And if you lack confidence in earnings announcements, there is certinaly little else to be "confident" about.
There is little doubt that when you look at real personal income excluding government transfers, industrial production, and real trade sales, that the recession statistically ended in June (employment has continued to drop but this for some reason has historically not been as important as, say, industrial production in the National Bureau of Economic Research’s (NBER) thought process). But the depression is ongoing even if the most recent recession has faded; and in our view, the next one is not too far away especially now that the stimulus is soon to subside.
What really strikes us is the anecdotal evidence suggesting that a recession mindset is still fully intact as far as the general public is concerned — and we’re not just talking about the President’s dismal approval ratings on how he is handling the economy. On Friday, we received the February reading on the University of Michigan consumer sentiment index and it came in at 73.7 — believe it or not, this is still fractionally below the averages of all the prior recessions (73.9). In real organic economic expansions, the UofM survey is 91.0; even at this stage of the jobless recovery in 2002, with the lingering tech wreck and Enron-related concerns and the onset of war, this index was sitting at 88.0 or fully 14 points above where it is today.
In a post-bubble credit collapse, history tells us that consumer attitudes towards discretionary spending, borrowing and housing undergo a transformational shift. Look at Chart 1 and you will see how attitudes towards homeownership has altered, and this is a secular change and explains why there has been so little traction on the demand side despite the best affordability conditions in at least a generation. A mere 3% of respondents to the UofM survey see housing as solid investment. This is well below the 24% who thought so back during the bubble days as the homeownership rate hit new all-time highs of nearly 70% as the boomers increasingly viewed real estate as some viable retirement asset instead of what it really is — a place to live and raise your family.
The aspect of housing supply that no one understands yet is that everyone wishes they still lived in the house that they sold to buy the one they now own. This is especially the case for the baby boomers who only need 1,800 square feet and a very small yard (and close to work). They bought their oversized home during the bubble years because they believed that the price would always go up, there would always be liquidity and they really wouldn’t need to pay off the loan out of earned income. The mortgage would be retired at the closing table, which they would get up from with a big check. This was why they bought a house that was much larger and more opulent than they really envisioned themselves living in during retirement. It was half-dwelling and half-investment. You can imagine that the fashion really changed a while ago. At the margin, the boomer population may not be as attached to the status quo as some think —it now wants to rid itself of the declining asset, but it is even more critical to rid themselves of the debt and the maintenance expenses.
In a move-up market, more debt is being taken on and at the margin there are plenty of buyers to meet the sellers. But trying to make the movie run backwards is incompatible with Mr. Market. As the society tries to get small, the marginal transaction is driven by sellers who are liquidating debt and you can ponder what that means. I am pretty sure that the bottom line is that all of the buyers are going to be operating in a backdrop of a much bigger supply of sellers than anyone is currently thinking about and that is why supply and demand will take many years, not quarters, to come into true balance.
In most cases, sellers will have to come to the table with a check. That will be another source of selling pressure on liquid assets and the household budget. It’s worse than the selling pressure on consumer durables because this asset has a voracious appetite; it is both highly leveraged and declining in price. The pressure to walk away has nothing to do with the ability to make the mortgage payments. The public is going to come to understand that the lender has to bear some of the cost of the risk that was assumed when the financing was obtained. This is why something as unthinkable as a mass negotiation with lenders has become a reality. Since sales will be so difficult to transact, the lenders will continue to enter into deals that keep families in their homes. This is a new reality. Those deals will have to reflect a big enough write-down and rate concession to keep people in houses they don’t want (as was the case with ‘73 Lincolns).
In other words, the deflation cycle in residential real estate is far from over, in our view. Today’s Wall Street Journal runs with Foreclosures Seen Still Hitting Prices on page A5 and it cites a just-published John Burns study, which estimates that five million homes and condos out of the 7.7 million that are currently delinquent will go through the foreclosure process in the next few years. This represents 10 months of potential inventory to hit the market, in addition to the 7.2 months already reported in the ‘official’ resale figures. The only reason why there has been any stability in the Case-Shiller home price index in recent months was due to the government efforts to slow the number of foreclosed properties hitting the market — but that has been just a temporary reprieve (also see A Battered City Fears the End of Housing Aid on the front page of yesterday’s NYT).