Earnings Strength, Employment Weakness

by Mitchell Clark, B. Comm.

The bear market rally in stocks is just that — a bear market rally in stocks. The earnings from Johnson & Johnson (NYSE/JNJ) perfectly illustrate my contention that stocks will go up while the economy remains in a funk.

As I wrote last week, stockholders demand growth in revenues and earnings. In a recession, however, growing revenues is extremely difficult. For most businesses, the goal in a recession is to protect what you have and not lose too much in the way of sales. On the earnings front, the goal is the same. In order to do this in a recession, a business needs to cut expenses and, in most cases, the only way to do that is to cut workers or reduce salaries.

So, you can get the peculiar situation that’s developing now where the employment situation is getting worse, while the stock market is going up. The inverse relationship between Wall Street and Main Street is beginning to pan out once again.

Johnson & Johnson, one of the best managed pharmaceutical/consumer product companies in the world, reported that its 2009 first-quarter revenues dropped about seven percent to $15.0 billion. The negative impact of currency translation accounted for six percent of this total drop, which means that, operationally, the company’s sales dropped only slightly.

Earnings for the first quarter of 2009 were $3.5 billion, representing a slight decrease of 2.5%, as compared to the same first quarter in 2008. Diluted earnings per share for the first quarter of 2009 were $1.26, which was the same as the comparable quarter last year.

So, I see a scenario playing out for the rest of this year where corporations keep their earnings relatively flat, but unemployment keeps ticking higher. What this means is that the housing sector won’t recover anytime soon, with income, retail sales, and price pressures being weak. So, we have the counterintuitive situation, whereby the fundamental, real economy should stay weak, while the stock market trades in a big range.

This is what I expect for stocks: continued strength over the very near term with the strong likelihood of another major pullback; one big trading range at least until the fourth quarter.