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With companies like American Express, Dupont, Tyco, Walt Disney, and Exxon Mobile slated to report earnings in the upcoming week, it is not as if 2Q03 earnings season is in the history books. Rather, the ‘better than/worse than’ expected hoopla will not stop until Cisco unofficially ends 2Q03 e-season next week. Thus far, the ‘operating’ earnings have proven easily beatable, with 65% S&P 500 companies having ‘beat the Street’. Less than 200 S&P 500 companies are left to report.
As has been the case since the late-1990s, the surface analysis of most earnings releases has been based upon the immediate reaction in the stock market. To be sure, as CNBC hurriedly flashes EPS/Rev statistics across the screen, describing how investor’s ‘feel’ about these results is invariably based upon the immediate direction of a company’s stock price. This would not be so much of a nuisance if the media and Wall Street focused on 10-Qs with the same vigor as they do EPS releases. However, by the time many companies get around to filing their actual 10-Qs – audited reports which abide by GAAP and in some cases list items (stock options) which were not covered in PR releases - Wall Street is already focused on the next quarter.
Will Dividends Promote a Stock Market Rally?
Kodak, which reported a 60% decline in earnings on flat revenues, maintained its dividend policy. With Moody’s warning of downgrades, revenues actually down 6% in the quarter excluding currency gains, and the company betting that more job cuts and new products will boost future earnings, the case could be made that the company’s dividend is in jeopardy of being cut. Other Dow components that have raised dividends include AT&T and Citigroup.
Jeremy Siegel expects the average dividend yield on the S&P 500 to nearly double next year to 3%. Assuming the bond market does not suffer a complete meltdown, and/or the expected slowdown in the housing market is countered by a pick-up someplace else, rising dividend yields are sure to support stocks prices. In fact, I would speculate that if every public company in America completely stopped buying back stock and instead began paying out this cash in dividends, that the bearish case against stocks would all but vanish. Say what you want about the Kodak’s, but a company yielding a couple hundred basis points more than the 10-year Treasury doesn’t collapse unless shareholders ‘feel’ certain that dividend cuts are coming.
Even so, the theory that dividends will spark a fantastic rally is not impenetrable. For starters, the estimates being tossed around – that “Shareholders will pocket $9.2 billion more from Standard & Poor's 500 Index companies in the next year” - could prove as reliable as the long-term surplus estimates made in 2000. Moreover, it is not as if companies like Kodak abound, and/or that there are many ‘safe’ dividends that are readily more attractive than government bonds. Rather, the average dividend yield on the Dow is roughly 2.2% and the average yield on the S&P 500 is less than 2%. Even if you double these yields – an impossibility from increased payouts alone in 04 – how investors perceive stocks in general is likely to determine what stocks prices will do more so than stock yields.
Incidentally, it is well worth remembering that the average dividend yield on the S&P 500 rose above that of bonds (30-year) for 20-years in succession beginning in the late 1930s. Did investors not know they could get a better yield in stocks than in bonds during these years? No. Rather, they didn’t care…
Two Key Economic Releases
While earnings will remain in the spotlight, this week’s batch of economic reports could steal the show. In fact, if expectations are met – a slight increase in payrolls and a reading above 50 in the ISM – it is difficult to argue that the recovery cheerleaders will not be holding a rah-rah session by Friday. And while July consumer confidence readings could also play a role in sculpting investor sentiment, it is the jobs and manufacturing stats which likely make or break the week.
Last weeks reports – including better than expected readings in durable orders, weekly jobless claims, and leading indicators – added fuel to the recovery theme. However, and to reiterate, as expected or better than expected jobs numbers could be the report that turns the smoldering recovery theory into a full fledged bon fire.
Conclusions
If you believe that Greenspan and Bush’s economic bailout policies can keep the sluggish U.S. expansion moving along, you buy Kodak and keep your fingers crossed. On the other hand, if you believe that Kodak’s yield is high for a legitimate reasons - that the next move lower in the dollar will not be met with investor jubilation, and that the longest ‘recovery’ in history is simply delaying the inevitable contraction - then you stay away from Kodak. Knowing something about Kodak the company could also be worthwhile, but who wants to seriously research companies when following macro economic speculations is so easy?
Kevin Hassett, of Dow 36,000 fame, states that ‘the deficit is no reason to be negative about the economy’. OK Mr. Hassett, but does this mean deficits are a reason to garner a positive outlook on the economy???
Seabiscuit was a small horse that defied expectations and ran rapidly. The crowds cheered Seabiscuit during the Great Depression, apparently because this little horse gave people hope...
The horses giving investors hope today move in the form of stocks prices. When these prices race ahead people want to bet on the underdog. Ironically, it is all the bad news - government deficits, the 3-year bear market, accounting implosions, fraud, etc – which gives this rally an underdog status.
In sum, although I am not exactly sure when the current rally will lose its legs, I highly doubt that 65-years from now they will be making a movie about all the brave investors who bet on this dark horse rally. Rather, a more likely scenario is that the current Seabiscuit rally pulls up lame the second the dark horse becomes the favorite. In other words, while a flurry of positive economic news could propel stocks higher in dramatic fashion, it could also mark the beginning of the end.
With each race won, the payout on Seabiscuit diminished...The same holds true for stocks.
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