Trader Talk

Complacency Is High—Beware Central Bank Letdowns


European Central Bank
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Complacency is high; beware central bank disappointments.

Mario Draghi has said he would do anything to save the euro . The markets may hold him to that.

We have seen a modest rally in the euro and in international markets in the last week. The reason is the expectation of aggressive stimulus from the Fed and ECB, and that worries me.

But there seems to be a little bit more to the stock market. The S&P is up over 10 percent this year. That is a big gain. But to be bullish right now, you have to make very positive assumptions about some very big issues:

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1) An aggressive stimulus from both the FOMC and the ECB. But the Draghi/Bernanke put may be overbought. Traders are expecting big things from the ECB, but the Germans have already thrown cold water on a banking license for the European bailout fund.

But the other alternatives are likely not a big enough bazooka to make a difference for very long. A rate cut is not enough. The market wants to see bond buying—and it's got to be big. "They need a number with a 'T' in front of it," one commentator told me, meaning a trillion-euro bond buying program. That's what they might need to buy significant time for structural reforms. That seems unlikely. They are not going to get the green light on numbers that big, absent another massive crisis.

Another point: the ECB has bought north of 200 billion euros in bonds since May 2010; it hasn't made a huge difference. They are not buying enough to offset the private investors, who are selling. They are trying to intervene, and it doesn't seem to be working.

2) Structural reforms in Italy and Spain. But they are going slowly, and if the economies do not improve, the austerity measures will be rolled back.

3) The fiscal cliff goes away. We've heard that allowing the Bush tax cuts to expire will cut GDP growth several points in 2013; the market is assuming this will be addressed.

4) Another double-digit gain in earnings in 2013, on top of expected record earnings this year. This is what really worries me: the stock market is priced on a multiple of earnings ultimately, and the numbers in the past month have been going in the wrong direction.

Earnings are coming down fast, not just for this quarter, but for the next two:

Earnings estimates, 2012

Q2 down 0.2%

Q3: down 0.8%

Q4: up 10.9%

Source: S&P Capital IQ

Take note that Q4 is where all the earnings growth is this year, but that number has gone from almost 16 percent a month ago to 10.9 percent, and is dropping fast.

Here's what's worrisome:that 10.9 percent gain for Q4 will likely drop into the mid-single digits. I don't think the markets have factored that in yet.

And even with the lower earnings estimates, we are still expecting record growth in earnings this year — that's right, record earnings — $103 on the S&P would be an all-time record, and we’re expecting ANOTHER record year in 2014:

Record earnings?

2011: $99

2012 (est): $103

2013 (est.): $114

Source: S&P Capital IQ

This, at a time when revenue growth will be anemic at best:

2012 Revenues estimates

Q2: up 2%

Q3: up 2%

Q4: up 3.3%

Source: S&P Capital IQ

We are going to have a tough time getting to 1,500 on the S&P 500 in 2013 with revenue numbers like this.

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