The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks.
Investors are in an Oscar the Grouch-like mood. But unlike the fuzzy, green Muppet, they don't love trash. And that's exactly what the latest slew of corporate earnings reports are: Dirty, dingy and dusty. Rotten, ragged and rusty.
That follows weak guidance from Caterpillar (CAT) on Monday, and a big drop for the market on Friday following disappointing results from tech giants Google (GOOG) and Microsoft (MSFT) as well as lackluster numbers from General Electric (GE) and McDonald's (MCD).
Nearly all of these companies mentioned challenging macroeconomic environments around the globe that is crimping demand for their products and services. Several suggested that they will be restructuring in order to boost profits, with DuPont announcing 1,500 layoffs. Chipmaker AMD (AMD) also let forth a deluge of pink slips last week, announcing it would cut 15% of its workforce.
This relentless drum beat of poor corporate news should not come as a surprise to anyone. China's economy is undeniably slowing. Europe (particularly Greece and Spain) still looks like a triage center.
And while growth in the United States seems to be stabilizing, that could all come to a grinding halt if Congress closes its eyes and takes a step off the fiscal cliff at the end of the year.
But guess what? Even though the S&P 500 has slumped nearly 3% in the past five days and the broader market may finish October in the red, investors may need to prepare themselves for an even deeper pullback in the coming weeks.
Companies are no longer able to cut expenses fast enough to compensate for sluggish sales. They did that already in 2008 and 2009. The only way for earnings to significantly improve over the next few quarters will be if demand gets better. Plain and simple.
Lacking that, the market still seems ripe for a bigger downturn. Considering that some high-profile bellwethers such as Apple (AAPL), Google, Verizon (VZ) and IBM (IBM) have either already entered or are very near correction status (i.e. down 10% from recent highs), shouldn't the broader market do the same?
The Dow and S&P 500 are only 4% below their 52-week highs. The Nasdaq is getting closer to a correction, which makes sense given that Apple is such a huge component of that index. But it's still down just 6.8% from its 52-week high and remains up nearly 15% in 2012.
Now the good news for market bulls is that valuations are still relatively attractive for stocks. The S&P 500 is currently trading at 13 times consensus earnings estimates for 2013 according to Thomson One. That seems reasonable for now.
But analysts are only predicting earnings growth of 7% for next year. What if those estimates get cut? That's a plausible scenario given all the aforementioned global risks. A mid-teens market multiple may be too expensive if earnings are only going to increase in the low-to-middle single digits -- which is why stocks arguably need to fall further.
It doesn't appear that investors have priced in the possibility of slow economic and earnings growth in 2013 yet. If stocks pull back a bit more, that could set investors up for a nice rally next year if results do turn out to be better than forecasts.
But some of the other companies that were bright spots in the market Tuesday merely beat low expectations. Yahoo (YHOO) rallied on an earnings beat and hopes that new CEO Marissa Mayer will finally turn around the struggling Internet media firm. That's a company-specific story, not a sign that online advertising is robust. We already got the bad macro news from Google last week.
Likewise, motorcycle maker Harley-Davidson (HOG) revved higher even though profits and sales fell from a year ago. They just didn't fall as much as analysts were expecting. Hardly cause for raucous celebration.
Keep that in mind if Netflix (NFLX) and Facebook (FB), two down-on-their-luck tech stocks, report better-than-expected results after the bell Tuesday. The bar for them is low. What investors will need to see to get excited about the broader market are strong results from the likes of Apple, AT&T (T), Amazon (AMZN) and Boeing (BA) later this week.
For now, earnings are, to quote our friend Oscar again, just like that fish he's got wrapped inside some old newspaper. "Smelly and cold." And the market would trade those earnings for a big pot of gold.
Not a member yet?Sign up now for a free account