The S&P 500 is up 15% from its October 4 lows. As of Friday, 136 of the S&P 500 have reported third-quarter earnings. Two-thirds (91) registered a positive earnings surprise. Analysts now project that third-quarter earnings will be 14.7% above last year’s third quarter, compared with analysts’ October 3 estimate of just 13.1%. Perhaps that explains the surprisingly strong October market rally.
This is the 11th straight quarter of positive earnings surprises — so next time you hear complaining about the lack of growth on Wall Street, remember that’s simply not the case for many stocks.
While selected technology stocks are helping lead the overall stock market higher, financial stocks are still struggling. Despite the problems that financial stocks in Europe and the U.S. are having, the woes in the financial sector are causing a welcome exodus from value stocks (dominated by financials) to growth stocks. Many investors who went into cash during the European financial crisis are now tip-toeing back into stocks, especially now that the S&P 500 sports a higher dividend yield than 10-year Treasury bonds.
During the recent correction, the stock market experienced a “crisis of confidence” similar to the 1979 “malaise” when Jimmy Carter was President. However, the stock market tends to rally heading into a Presidential election year. In the interim, not only is the stock market basking in better-than-expected third-quarter earnings, but the seasonally strong time of year is fast approaching. Typically, the market soars from October to January in a strong year-end rally.
Bad news will always exist, but the difference this October is that the stock market continues to shrug off bad news while focusing on positive third-quarter earnings. These earnings reports calm our fears about a double-dip recession and give hard answers to the key questions motivating most investors: “Show me the money” and “Where’s the beef?” The financial markets are frankly tired of hearing the latest news from Europe regarding their sovereign debts, or the recapitalization of their banks, or the latest strike in Greece.
Forget Europe! The bottom line is that the rest of the world just keeps growing.
Turning to the global economy, I continue to watch China’s growth rate more than the problems in Europe. On Tuesday, China’s National Bureau of Statistics reported that GDP growth “slowed” to an annual pace of 9.1% last quarter, down from 9.5% in the second quarter and 9.7% in the third quarter of last year. This is like slowing down from 165 miles per hour (mph) to 155 mph! China’s industrial output surged 13.8% in September vs. a year ago. This is hardly indicative of an economic slowdown.
Some economists are concerned that China’s trade surplus is shrinking, but China’s soaring imports are caused by rising domestic demand, due to a rapidly-growing Chinese middle class. As a result, China’s economic growth is now more balanced than ever. In addition, a booming middle class is fueling strong economic growth in the rest of Asia, especially India and Latin America. As a result of this emerging demand, the International Monetary Fund (IMF) sees global GDP growth at 4% in both 2011 and 2012.
In Europe, of course, the economic outlook is murkier. Many European banks are in the midst of being recapitalized. On Tuesday, Moody’s downgraded Spain to A1 from Aa2 and said that “no credible resolution of the current sovereign debt crisis has emerged.” Moody’s also warned that France may lose its coveted AAA rating and issued a “negative” outlook, which often precedes credit downgrades.
Meanwhile, American corporations continue to issue debt at extremely low interest rates, so that they can buy back their low-priced stock. For example, Coca-Cola recently issued 10-year bonds yielding 2.375% and short-term notes at only 0.05% above LIBOR. Since Coca-Cola’s return on equity (ROE) is 41.3%, and it can borrow at 2.375% or less, the company is aggressively buying back $2 billion of its stock, thereby boosting earnings per share!
This stock buyback frenzy will continue to lift earnings in 2012.
