Earnings Reports Masking the Rest of the Equation: Risk Remains High

Earnings Reports Masking the Rest of the EquationIt is earnings season and corporate numbers are plentiful. Blue chips are mostly reporting decent financial metrics, but I want to address the other side of the equation.

Investment risk in many capital market assets is still very high. And the reason why it’s very high is the fiscal and monetary experiments taking place around the world.

PepsiCo, Inc. (PEP) announced another good quarter that beat expectations, and while the outlook for the beverage and snack market is decent, this is only part of the picture facing equity market investors.

It is still important for investors to be extremely cautious (and conservative) in this environment. The sovereign debt crisis has not abated in the eurozone. U.S. monetary stimulus through artificially low interest rates and quantitative easing is not re-inflating assets to the degree wished for by the Federal Reserve. The U.S. fiscal situation remains a mess at all levels of government.


I’m the biggest believer in enterprise and taking a constructive view of equity market trading action. But there is this whole other universe out there of unquantifiable risk precipitated by undercapitalized banks, no fiscal flexibility, and exponential money supply stimulus that, so far, hasn’t created real, unassisted economic growth.

I’m not a “doom-and-gloomer,” but investment risk is equally, if not more important than potential returns with paper assets. And the world (including regulators) still can’t quantify the risk exposure within the global derivatives market.

This is still very much a perilous environment, as private economic deleveraging butts heads with public economic re-leveraging. Risk hasn’t gone away; it’s only being masked by the equity market. (See “The Only Way to Protect Your Investments from the Turmoil in China.”)

I absolutely believe that all equity market participants need to re-evaluate their portfolios for risk exposure. A long-term or retirement portfolio should include only the most solid companies, with dividends being paramount. I also see nothing wrong with holding cash, as there is no rush to buy in an equity market that’s already had a great run and is due for a serious correction.

Memories in the investment business are short, and the daily news (earnings season reports) in this equity market easily masks the previous reality that hasn’t changed.

Some financial metrics on the U.S. economy are showing improvement. But this is only with the certainty of the stimulus provided by monetary policies. The Federal Reserve does what it does best, and that’s printing money. But this equity market is still very fragile and investor sentiment, while glimpsing the end of quantitative easing, realistically can’t handle it yet.

There is no rush to take on or add to new positions in stocks. And it’s not that the best companies and trades aren’t out there; rather, it’s because of the other side of the return equation—investment risk. The equity market almost came apart just recently as bond yields spiked on a misinterpretation of Federal Reserve chairman Ben Bernanke’s words.

Near-term, things will probably tick along the current status quo in the equity market. September is the next big catalyst, with a huge Federal Reserve policy meeting for Ben Bernanke—the last time that he will have the chance to decide to either keep or taper quantitative easing before being replaced by his successor.