Farrell: Better Earnings Still Ahead?

It looks like we are seeing a pickup in demand that might make the better earnings we have seen this quarter become more likely to be repeated in the quarters ahead. The difference we need to see in the makeup of earnings needs to be growth from better revenues and not a reliance on cost-cutting. The current issue of Business Week (Jim Cooper's column) says that growth is starting to be influenced by better demand and not inventory swings. From my seat, I still see inventory liquidation. That implies production cutbacks, but also some demand pickup for the inventory to be moved. Corporations have good balance sheets with larger-than-normal cash positions and are well positioned to respond financially to a better environment. Earnings the past few quarters have increased at a 25% annual rate, and that in a recession.


But in this past crisis, employment fell at a far faster rate than production, which implies payrolls are too low, especially if there is any improvement in final demand.

Private sector employment is back to where it was a decade ago, but GDP, even after the recent slump, is up by a solid double-digit number. That would support the argument that too many jobs were eliminated. We need to see initial unemployment claims plunge to confirm the theory that too many jobs were cut. We also need to see the number of temporary jobs increase since that is usually the first signal that better jobs numbers are on the way.

Working against corporate America's willingness to expand would be the very uncertain regulatory environment that encompasses so many areas. Financial reform is still to be determined, and cap and trade climate legislation could take many forms. Health care costs are a perpetual problem made more complicated now by the uncertainty of reform proposals. All of this could make employers hesitant to add workers. But maybe not temp workers, which is why that number will be a focus.

Existing home sales announced last week were good on several levels. The number of sales surprised a bit on the upside, coming in at 5.57 million. That is the fifth month out of the last six that sales have been up. The median home price was $174,900, down 8.5% from a year ago. But that is better than last month, which was down a much-larger 17.5% versus last year. The "second derivative" (change in the rate of change) is swinging to our favor. The almost 5.6 million homes sold was up 9.4% from the number sold in August and up a solid 24% from January of this year. "Pending" home sales would imply next month will see sales more like 5.8 million.

The news from China (and most of the emerging markets) continues to be good, as we noted several times last week. The Eurozone is doing its best to participate in the recovery. Consumer spending in France rose a much-better-than-expected 2.3% month-over-month in September. The "Euro Area Purchasing Managers Index," a combination of both manufacturing and non-manufacturing surveys, lifted to 53 from 51 in September, the highest reading since September of 2007. Euro Industrial Orders were up 2% in August, and that was the fourth month in a row of increase. A thing called the German IFO business climate survey hit a 13-month high. The news from the U.K. was not as good, as they reported a negative GDP for the sixth month in a row. Total GDP has fallen by 6% over this time span.

Lots of auctions of U.S Treasury bonds this week. Some Treasury Inflation Protected Bonds — TIPS — will be sold Monday. The big issues will be $44 billion of two-year notes on Tuesday, $41 billion of 5-year paper on Wednesday, and $31 billion in seven-year notes Thursday. Treasury issuance will be unrelenting and will probably not peak in size until well into 2010. The 10-year yield, now about 3.5%, will be the canary in the coal mine for sentiment as to how long the world will continue to finance our deficit at historically low rates.