Back in Market Kindergarten, it was all so clear. See corporate profits. See the markets. Corporate profits are the market's best friend. They go everywhere together.
One day, the happy profits go up. See profits go up. Up, up, up. See the market. Market sees profits. Market goes up, up, up - right?
Well, oddly enough, no. This time, market goes nowhere. Bad, bad market.
Why must we live in this harsh real world, where those lessons we learned in our youth are thrown out the window by markets that never quite behave themselves?
Therein, kiddies, lies another little lesson - the one about expectations and reality. Like neighbours in a thin-walled apartment complex, things are quiet and calm when they get along and have a good understanding, but things can get pretty wild if they don't see eye to eye. This week, the reality of third-quarter profits came out, waved a neighbourly hello to expectations, and the market trundled on its way with little more than a murmur.
Several prominent companies posted huge third-quarter profit gains in the week. Intel Corp.'s bottom line surged 142 per cent from a year earlier, while fellow tech giant IBM Corp. posted a 37-per-cent improvement. Apple Computer Inc. turned in a profit of $44-million (U.S.), reversing the $45-million loss of a year earlier. In the financial sector, Merrill Lynch & Co. Inc.'s profit jumped 50 per cent, while Bank of America was up 31 per cent. Big auto maker General Motors Corp. rose to a $425-million profit from a year-earlier loss of $804-million, while Ford Motor Co. trimmed its loss for the quarter to $25-million from $326-million a year earlier.
Yet these bullish corporate reports barely registered a ripple through North American stock markets. The blue-chip Dow Jones industrial average inched up 0.5 per cent in the week, while the broader S&P 500-stock index an even thinner 0.05 per cent. In Toronto, the S&P/TSX composite index gained 1.1 per cent on the week.
Profits, the prognosticators say, are set up for a 20-per-cent year-over-year rise for the third quarter. That's not a bad little pop, is it? And there was nothing that came out of this week's quarterly results that has shaken their confidence. Only problem is, equity markets have already priced in that kind of rise, and then some. Over that same year, the S&P 500 and the Dow are both up 22.1 per cent, while the Nasdaq composite is up a whopping 58 per cent. The S&P/TSX composite is up 26.6 per cent from a year ago. All the profits are doing is playing catch-up.
Keep in mind, too, that the U.S. economy has been white-hot in the third quarter. Even long-time bear David Rosenberg of Merrill Lynch ratcheted up his gross domestic product growth estimate for the quarter, to a whopping 6-per-cent annualized rate, and some experts say the number could come in even higher. With that kind of growth, you'd expect to see some pretty impressive profit numbers. And that third-quarter growth spurt almost certainly won't be duplicated in the fourth quarter.
In that light, it's hard not to think that the stock markets have gotten way, way ahead of profits this year. Just how far ahead? The S&P 500 is trading at nearly 30 times earnings. With the exception of the tech bubble, it has only had a multiple that high on one other occasion: 1929.
That reflect a lot of anticipation of good things to come - and this week, it looked increasingly like the markets have had enough of anticipation. It's Christmas morning, show-me time. So far, companies are coming through with the promised gifts and everyone's content.
But given how bloated the market has become, we're gonna have to see one hell of a nice new bike under the tree to get excited again. And watch out if a few big companies hand over a lump of coal, because there's some serious danger of a good pout. (We saw some of that yesterday, when the markets slumped after seeing less-than-adequate profit numbers from Sun Microsystems and eBay.)
With that in mind, investors will want to keep a close eye on the myriad third-quarter reports coming down the pipe next week, as the reporting period gains momentum. Because while the markets have shown a resistance to going up along with profits, there's a real danger that if profits fall down, markets could go tumbling after.
E-mail David Parkinson at dparkinson@globeandmail.ca
© The Globe and Mail
Only GlobeinvestorGOLD combines the strength of powerful investing tools with the insight of The Globe and Mail.
Discover a wealth of investment information and and exclusive features.
