The markets have been on a killer run. The earnings are coming in better than expected for many companies. All earnings are not created equal, and we need to ask ourselves - Where are these earnings coming from?
The earnings are driven primarily by cost cuts and reductions in workforce. If I look at my own steel business, net earnings were phenomenal in the 1st and 2nd quarters. They were great because of a huge reduction in workforce and massive overhead cuts that we made in 4th quarter of 2008. This is why I can tell you that no way we will meet or beat the earnings we saw in 1st half of the year going forward.
The earnings are driven primarily by cost cuts and reductions in workforce. If I look at my own steel business, net earnings were phenomenal in the 1st and 2nd quarters. They were great because of a huge reduction in workforce and massive overhead cuts that we made in 4th quarter of 2008. This is why I can tell you that no way we will meet or beat the earnings we saw in 1st half of the year going forward.
Here is the chart I receive each month from our freight companies, reflecting what is called the Freight Indexes. They measure the demand for Truckload services compared to the number of trucks on the road. The index begins in April 1994. When a reading is above prior years’ level it means there is more freight demand relative to available capacity. When a reading is below prior years’ level, it means there is less freight demand relative to available capacity.
As you can see, 2009 (Red Line) is down by a huge margin. Although we saw an uptick in May and June it is nowhere close to average.
The private company I am involved in has only recently seen the slightest of upticks in business activity - while selling for minimal or no profit margins. The steel companies have recently worked off old inventory and now they will need to see demand in order to replace that inventory.
For now that demand is seen only in a few small areas - it is not broad based. This appears to be a rebound from cost cuts and not demand-driven. Cost cuts have a one-time impact on profits until demand reappears. It should be interesting to see how things will develop now that Q2 earnings come to pass and we must look forward to Q3.
As you can see, 2009 (Red Line) is down by a huge margin. Although we saw an uptick in May and June it is nowhere close to average.
The private company I am involved in has only recently seen the slightest of upticks in business activity - while selling for minimal or no profit margins. The steel companies have recently worked off old inventory and now they will need to see demand in order to replace that inventory.
For now that demand is seen only in a few small areas - it is not broad based. This appears to be a rebound from cost cuts and not demand-driven. Cost cuts have a one-time impact on profits until demand reappears. It should be interesting to see how things will develop now that Q2 earnings come to pass and we must look forward to Q3.
Kerry,
ReplyDeleteThanks for very much for the insights--certainly the steel industry is at the foundation of the economy.
Grant
Kerry’s comment is another example of the disconnection of the equity market with the real economy: 45% within 4 months for the SP500 whereas it took 11 months from march lows 2003 to reach such a percentage.
ReplyDeleteThe commercial real estate has been collapsing at a pace faster than the housing one (1) whereas banks will have eventually to show losses in their balance sheets (2). Banks are very reluctant to lend money to the companies and to the consumers whereas we have an economy based on the credit.
China is the Savior and the Conference board’s leading indicators are up for the third month in a row. Here is the consensus and the fact that market is always ahead. Economy will catch up. The American economy is much more flexible than the European one. Could we count on this for a fast recovery helped by a stimulus package still to spend?
Trade (short term) and see.
(1) see Moody’s real commercial property price index
(2) Banks don’t have to take write downs until an event of default. When the default comes, they do everything possible to avoid taking a loss (interest rate reductions, delayed principal payments, etc). At the bottom line, whatever they do, the value of properties will be much lower than the value of the mortgages. From an accounting perspective, it will pop up sooner or later. Currently, do their stock prices reflect this fact?
"double dip recession"?
ReplyDeleteas painful and as awful as it sounds, that's what we may be in for :(
Thanks for the insight Kerry!
Stephen M.