New Trick: How U.S. Companies Are Propping Up Their Profits Now

corporate earningsWith the majority of the companies in the Dow Jones Industrial Average releasing their corporate earnings in the current and upcoming weeks, we should really get a feel for how the economy is performing.

Why all the fuss about this year’s third-quarter earnings?

Companies in key stock indices are on track to showing negative corporate earnings growth in the third quarter, compared to the third quarter of 2011. We have already seen a poor performance by Alcoa Inc (NYSE/AA), and a large number of other big-cap companies giving warnings about their corporate earnings—International Business Machine Corporation (NYSE/IBM), Intel Corporation (NASDAQ/INTC), FedEx Corporation (NYSE/FDX), and The Procter & Gamble Company (NYSE/PG) have already either reported or warned about weaker-than-expected earnings growth.

In fact, last night, International Business Machines (IBM) reported third-quarter revenue that missed analyst projections. The stock was down 3.2% in after-hours trading. Last night, Intel reported fourth-quarter gross margins that also missed expectations; that stock was down 2.8% in oversees trading. And giant Potash Corporation of Saskatchewan Inc. (NYSE/POT) reported this morning that its earnings for the full year will be below the low end of its previous estimated profit per share. The reason, according to newswire service CNW, consists of “delays in new contracts with buyers in China and India.”

More companies in key stock indices will provide negative guidance about their corporate earnings, as big-cap companies are struggling due to the slowing U.S. and global economies.

In the current stock market, what we have is executives fleeing (the insider selling-to-buying ratio is at a record high), declining earnings growth, and low participation (low trading volume).

The mainstream media has made it clear that U.S. corporations are holding a record amount of cash, but what you haven’t heard is where they are holding the cash. Cash held by offshore U.S. companies stands at $1.3 trillion—near an all-time high. (Source: Reuters, September 25, 2012.) What do they know that we don’t about holding money in the U.S.?

Big-cap companies in key stock indices are buying back their shares at a record pace. In the second quarter of 2012 alone, U.S. corporations purchased $95.9 billion worth of their own shares. This was an increase of 15.6% from the previous quarter. (Source: FactSet, September 28, 2012.) Major companies that purchased back their shares include Exxon Mobil Corporation (NYSE/XOM), ConocoPhillips (NYSE/COP), and IBM.

Stock buybacks might be great short-term news for shareholders. With the S&P 500 on track to showing its first negative corporate earnings growth in 11 quarters, however, increasing buybacks should be another caution sign regarding the rising key stock indices.

Looking at the issue from a broader perspective, in an environment of weaker corporate earnings, buying back shares essentially makes things look better than they actually are by making profitability per share look better than before, as the number of shares in circulation is reduced.

Rigorous expense cuts were the reason companies were able to show better-than-expected corporate earnings in most quarters since 2009. Now with little room to make cuts, other than reducing staff count, share buybacks are another option for companies to prop up their per-share corporate earnings. Be aware of this game being played by big-cap companies. Share buyback programs can certainly be good at times, but at the accelerated rate at which they are happening, this time the motives may be questionable.

Michael’s Personal Notes:

The Chinese economy was one of the main driving forces of the global economy after the financial crisis in the U.S. took a heavy toll. The Chinese economy and other emerging markets economies grew at an astonishing rate, and created demand around the world, while the U.S. economy continued to struggle.

Now, a few years forward, we are still seeing a struggling U.S. economy and, to top it off, there is extensive slowdown in emerging markets, especially in the Chinese economy.

The Chinese economy has seen its gross domestic product (GDP) grow significantly, but sadly, this year, according to estimates, it’s on track to only see growth of 7.7% and growth of 8.2% in 2013 (source: Market Watch, October 14, 2012)—worse than 2009, when the Chinese economy grew at a pace of 8.1% (source: National Bureau of Statistics of China, last accessed October 15, 2012).

With that said, recently there is a new wave of optimism created by the mainstream media and the financial gurus—they are now claiming that the Chinese economy is turning around. Their reasoning: according to customs administration, is that exports from the Chinese economy increased 9.9% in September compared to 2011. (Source: Bloomberg, October 14, 2012.) The Chinese economy is largely based on exports; if the exports increase, this means there is demand in the global economy.

This is definitely a good signal for the Chinese economy, but in the grand scheme of things, it doesn’t mean much. In periods of economic growth, what you want to see are consistent and less volatile results. In August, exports rose only by 2.7% compared to last year (source: BBC News, September 10, 2012).

Exports numbers do suggest some demand from the global economy, but what you have to keep in mind is that the eurozone—the biggest trading partner with the Chinese economy—is still struggling.

From the perspective of the global economy, everything is still bad, as expected—we are edging closer to a global recession than a recovery. The International Monetary Fund (IMF) has already slashed its outlook for the global economy—don’t be surprised to see more cuts. The situation is still getting worse, and there is simply no light at the end of the tunnel.

Be very careful about the noise that is being generated by the mainstream media and the financial market gurus. There is no economic growth in the global economy. If the Chinese economy is any indicator, it is suggesting the opposite of what the pundits are saying: don’t buy into the hype, look at the facts.

Where the Market Stands; Where it’s Headed:

As expected, earnings reports from public companies for the third quarter of this year are coming out weak. As I write this column this morning, giant PepsiCo, Inc. (NYSE/PEP) just announced that its net income fell five percent in the third quarter. The only companies reporting better-than-expected earnings are the financial companies and banks (thank you, Federal Reserve).

I’m wary about the stock market…a stock market propped up now for three years by expanding money supply more than anything. While I see a little more room for the market to rise, we are very close to a top for the bear market rally that started in March of 2009.

What He Said:

“As a reader, you’re aware I’m not a Greenspan fan. In the years that lie ahead, I believe we (and our children) may pay dearly for the debt bubble Greenspan created during his tenure as head of the U.S. Federal Reserve.” Michael Lombardi in Profit Confidential, March 20, 2006. Michael started talking about and predicting the financial catastrophe we began experiencing in 2008 long before anyone else.