Nascent Cycle, Change Signals and Imminent Government Budgets and Corporate Earnings

The nascent cycle of recovery and capital market sustenance requires substantively more changes. Investors are likely to need and indeed should demand (even more than ever) concrete signals from imminent deluges of government budgets and corporate earnings releases. For portfolios, if not counteracted by both governments and corporations, we find a cycle of dependency a risk which more is usually associated with other socio-economic endeavors such as native communities, ghettos and farm subsidies. Even by prior experience, aspirations and standards now need to be higher than self-congratulation about softening required restructuring by spending trillions of dollars of other peoples’ and other generations’ money. We remain watchful that instead of underscoring confidence in their own abilities, in high growth countries like India and in recession ravaged Europe/United States alike, business organizations appear still weighing in on the desirability of maintaining government stimulus. We are also watchful that deficit control appears not to be given its rightful profile even amongst the more right wing authorities, with central banks equally continuing to signal low administered rates as being desirable. Re-establishment of risk premiums would be concrete indications of change after months of momentum behavior. In turn, we believe those countries and companies co-opting such change are likely to competitively benefit and hence have a quality advantage to be favored by investors.

There is likely to be a stream of extraordinary budgets with pressure points already evident in recent weeks from Japan to Greece to Venezuela to Argentina with President Obama’s budget likely to have far higher scrutiny than his first one. In momentum since early 2009, versus a benchmark of 5% for 10 year U.S. T-Notes (incorporating a base with inflation and uncertainty premiums), its present yield is 3.78% with yields of BBB corporate bonds only 5.11% for instance. At the cusp of earnings reporting, investors need to be cognizant of the valuation impact of potential bond yields and the nature of the delivery content of the corporate earnings releases themselves. Our good friend Vincent Catalano (www.bluemarbleresearch.com) points to expectations of 80 for S&P 500 operating earnings for 2010 which if realized, would be well above ours of 75 and in our experience, one of the most rapid moves during a recovery of consensus from below to above our expectations. We have maintained a normality benchmark range of 15-18x for P/E ratios for the S&P 500 with the current market (1145) on annualized concurrent Q4/2009 slightly above this and on 80 slightly below this range. It seems to us that bifurcation could well characterize both markets and earnings delivery in the upcoming reports, even leaving aside the issue of write-downs and dilution in the financials.

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