Courtesy of The Pragmatic Capitalist

Another earnings season is around the bend and it’s shaping up to be another good one.   As we’ve repeatedly mentioned over the last 6 quarters the environment is and remains particularly ripe for profit outperformance.  The trends that have been in place for the last 6 quarters remains largely intact.  Analysts remain woefully behind in terms of raising their estimates (see here) and corporate profits remain a margin story.

Figure 1 shows the corporate profit margin over the last 40 years.   Most important in the last few years is the turnaround in margins since Q4 2008 when enormous cost cutting campaigns kicked in.   The one remarkably positive sign during this recession has been the ability of corporations to remain lean and mean.  They have done a superb job in cutting costs and maintaining a fairly robust bottom line.  As you can see, profit margins are surging in recent quarters and should continue to trend higher as unit labor costs remain low (see figure 2) and revenues begin a slow rebound (the extent of this revenue rebound will be the key driver of any future market performance).  This trend has continued this quarter and should help power another quarter of “better than expected earnings”.

Figure 1

Figure 2

While revenues have certainly bottomed it remains the key missing ingredient in the recovery.  In order for stocks to continue their record breaking trajectory we must begin to see revenue growth.  According to recent jobs data it looks like the labor market is beginning to firm.  This is a clear sign that companies are beginning to see more stability in their top-line growth.  This also means companies are beginning to incur extra costs and the margin story will cease to be the primary driver of earnings without equal or greater revenue expansion.  One bright sign here is that revenues significantly lagged the equity market rebound during the 2003 recovery.  As you can see in Figure 3 revenues didn’t substantially recover until 2004.  We’re seeing the same thing occur with this recovery although the extent of the rebound in revenues remains questionable as consumer balance sheets remain underwater and the global economy continues to drag itself out of recession.

Figure 3

Perhaps most important in all of this, however, is expectations.  As we mentioned earlier, analysts have been woefully behind the earnings recovery.  This is best reflected in our expectations ratio which had been trending higher since just before the market bottomed last year and only recently began to roll over.  This shows that analysts estimates are becoming increasingly in-line with actual earnings and could create an environment that is not quite so friendly to the usual “beat and raise” environment we have all become accustomed to.  If a strong revenue rebound fails to materialize in the back half of the year analysts estimates will prove too high and stocks will respond negatively.

Figure 4

Based on my analysis, I believe we are in for one more quarter (Q1 2010) of easy analyst comparisons and then the heavier lifting begins as estimates ratchet up in Q2 2010 and even higher in the back half of the year where analysts estimates are very optimistic.  If we don’t see a stronger rebound in revenues in the next two quarters companies will not match these optimistic outlooks.

Currently, the market appears to be front-running the current earnings season and is pricing in another very strong earnings season.  Don’t be shocked to see another quarter of very high percentage earnings beats and tepid revenue performance.  Whether that is enough for an already optimistic market remains to be seen.  My guess is we will see another “sell the news” earnings season.  Companies are running out of tricks to pull from the cost cutting bag and revenues haven’t quite stabilized to the extent that would make most executives highly confident in their full year earnings.  If we don’t start seeing a pick-up in top-line growth this market is not going to be celebrating for long and the recent optimism in stocks will be proven wrong.

Our friends at Elliott Wave International have just released a free 34-page eBook, Understanding the Fed. It’s the free report the Federal Reserve doesn’t want you to read!

This eye-opening free report, which represents more than 10 years of research by Robert Prechter, goes beyond the Fed’s history and government mandate; it digs into the Fed’s real motivations for being the United States’ “lender of last resort.” In this 34-page report, you’ll discover how the Fed’s actions, combined with public outrage, may ultimately lead to its demise, plus much more about its secret activities and how it affects your money.

Download your free copy of EWI’s Understanding the Fed eBook, here.

While the VIX is not something I follow on a daily basis it is important to keep an eye on it. When extreme low levels are reached we know the market (John Dow traders) are feeling confident and buying up everything they can get their hands on.

I like to trade with the trend but when extreme levels are reached I start looking for a low risk setup to the short side (profit in a falling market) using leveraged ETFs.

As you can see from the chart of the VIX and SP500 below, each time the VIX tested the support level the market made a top. Again the VIX is not a great timing tool but it helps me decide which trading strategy I should focus on (swing or day trading) and if I should be looking to buy or selling the market.

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NYSE New Highs-Lows Index

If a chart is worth a thousand words then this chart is worth 2000. It cannot get any simpler that the NYSE new high-low index.

The green line is the SP500 index which is straight forward. The Red line is the number of stocks on the NYSE which have reached a new high.

How strong is the market if is keeps going up while the underlying stocks are getting weaker? Something has got to give and it will most likely be to the down side.

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Dow Jones Industrial Average – Daily Trend Chart

This chart adds another layer of clarity. You can see what happened last January when everyone was buying stocks thinking life is good, trading is easy. As my trading buddy David Banister from ActiveTradingPartners.com always says “Buy when the Cry, Sell when they Yell”and that’s what I am looking to do.

Today the Russell 2000 index (small cap stocks) sold down very hard. These stocks tend to lead the market both up and down. So the red flag is up and I am just waiting for the market to show me its hand so we can catch the next big move.

Coles Notes on Chart:
• Market is over bought and in dire need of a pullback
• The length of this steady rally is much longer than a normal rally
• The rate as which prices are rising is much to steep to be maintained
• The market is trading at the parallel trend line
• VIX is tell us people are buying and not worrying about any possible drop
• NYSE divergence is screaming Overbought…

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GLD Gold Fund Trading

Gold is still in a major bull market but the recent price action from Dec up until now has been down as gold consolidates the large rally from 2009.

Looking at the chart below you can see the mini Head & Shoulders pattern. The neckline has now been broken and prices are falling. I almost had a buy signal for gold two days ago with the small move up and the candle closing above the previous days high. But because the price was still under the neckline (resistance) I decided to stand aside and live another day.

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Mid-Week Gold Newsletter Conclusion:

In short, the market looks very strong but from a technical point of view it’s about to die of exhaustion in my opinion.

Gold, silver and oil I figure will move together which is sideways or down.

I am keeping a very close eye on things hoping prices unfold in a manor which will allow us to spot a low risk setup in the coming days as I would like to catch this drop if it happen. With any luck we could make 10-15% within a couple days using a leveraged ETF.

If you would like to get my Real-Time ETF Trading Signals please check out my website: www.TheGoldAndOilGuy.com

This is an excerpt from Elliott Wave International’s free Club EWI resource, “What Can a Fractal Teach Me About the Stock Market?” by EWI’s president Robert Prechter.

In the 1930s, Ralph Nelson Elliott described the stock market as a fractal — an object that is similarly shaped at different scales. Scientists today recognize financial markets’ price records as fractals, but they presume them to be of the indefinite variety. Elliott found something different:

You see that each “wave” within the overall structure subdivides in a specific way. If the wave is heading in the same direction as the wave of one larger degree, then it subdivides into five waves. If the wave is heading in the opposite direction as the wave of one larger degree, then it subdivides into three waves (or a variation).

Understanding how the market progresses at all degrees of trend gives you an invaluable perspective. No longer do you have to sift through the latest economic data as if they were tea leaves. You gain a condensed view of the whole panorama of essential trends in human social mood and activity, as far back as the data can take you.

OK, now you try it. Figure 3-7 shows an actual price record. Does this record depict two, three, four or five completed waves? Based on your answer, what would you call for next?

Let’s compare your answer with mine. From the simple idea that a bull market comprises five waves, The Elliott Wave Theorist in September 1982 called for the Dow to quintuple to nearly 4000 and on October 6 announced, “Super bull market underway!” The November 8 issue then graphed the forecast for the expected fifth wave up, as you can see in Figure 3-8.

As you can see, Elliott waves are clear not only in retrospect. They are often — particularly at turning points — quite clear in prospect.

Visit Elliott Wave International to learn more about the free “What Can a Fractal Teach Me About the Stock Market?” report.

The Mess That Greenspan Made

The National Association of Realtors reported that sales of existing homes fell 0.6 percent in February after a drop of more than 7 percent in January and sales are now at their lowest level in eight months.
It’s probably best not to make too much of the winter data for existing home sales because it is a very slow time of the year when seasonal adjustments can have a big impact on the data and the weather was bad last month, but, that months of supply metric certainly looks to be going in the wrong direction right now.

Joe Weisenthal of Clusterstock

Tim Geithner is set to deliver unwelcome to news to those who play in the public Fannie Mae (FNM) and Freddie Mac (FRE) casino.

Bloomberg:

“Private gains can no longer be supported by the umbrella of public protection, capital standards must be higher and excessive risk-taking must be appropriately restrained,” Geithner said in testimony prepared for the House Financial Services Committee that was obtained today by Bloomberg News. The hearing is scheduled for tomorrow at 10 a.m. in Washington.

Geithner said the Treasury Department and the Department of Housing and Urban Development will issue a request for comment by April 15 on how to overhaul the U.S. housing-finance system and its regulatory structure. The government needs to make sure there is “no ambiguity over the status or allowable activities of any private entity which enjoys any benefits or protections from the government,” he said.

Unfortunately, he’s going to be extra-careful, and promise everyone that the administration isn’t about to pull the rug out from under reform or undermine the housing market.

Still, getting rid of the publicly traded stock — the fiction that these are private entities — would not be a bad first step.

CalculatedRisk

The Market Ticker

…. before our citizens – and government – wake up?
If you remember in October of 2008 I put forward the following:

The Truth is that we now require about $5 of debt to generate $1 of GDP.

The Truth is that the reason you were not asked to approve $700 billion to capitalize 10 new banks, thereby creating seven trillion in lending capacity is that the economy cannot soak up that new lending capacity; each dollar of new debt generates almost no aggregate GDP. If this were not true then that would be the logical and effective cure for the ‘credit crunch” – if the borrowing capacity and impact on GDP necessary to help existed. They do not.

The Truth is that you were lied to about the purpose of the TARP/EESA, because what you were sold was mathematically impossible. It is supposed to be unlawful to lie to Congress.

As I pointed out at the time, the reason they didn’t create that $7 trillion in new credit issuance is that there was no more capacity to take on new debt in the private sector.

They knew it.

They lied about what “had to happen” for stability to be restored.

They lied because the alternative was that their friends – powerful friends – would have to go bankrupt.

But it gets worse. Some of the other points:

The Truth is that the absolute worst thing you can do when “in the hole” like this is to spend even more on a deficit basis, thereby driving the debt ratio higher and return-per-dollar-of-debt in GDP lower. The last eight years have been disastrous in this regard.

Yet that is exactly what we have done – we have replaced fully 10% of private GDP with public spending, and while the claim was made that this is “temporary” the CBO says it is not, Obama’s budget says it is not, and the credit contraction that is continuing in the private economy says it is not.

Bernanke and Paulson, and now Geithner, know that this attempted “reflation” won’t – and can’t – work. They have put forward this path not because it is the right thing to do, but because the alternative means a lot of people with power and money will go bankrupt and the Government of The United States will have to change how it finances itself, removing the corrupt influences that have been used to “cook” the books – and outcomes – for the last 30 years.

We have blown three trillion dollars since these intentionally-wrong decisions were made, and we will continue to blow more and more money until the entire banking and economic system collapse unless we change course.

Nate has updated the debt-GDP contribution chart that I posted back in 2008 (and which was originally generated by Legg-Mason – it’s not difficult to generate it from the Federal Reserve Z1) and it shows exactly what I was predicting – and why the policies of the government and Fed not only haven’t but can’t work:

Now let’s be clear: Essentially all money is debt in our current system. As such attempting to “print” your way out, or attempting to “inflate” out, or attempting any act other than forcing the default of the bad debt in the system results in digging the hole deeper and deeper – that is, depressing private GDP further.

Government’s efforts have not helped, they have destroyed the four years we had before “zero hour” was reached. Bernanke’s interference in the mortgage market didn’t “help” that market, he effectively entirely replaced the private market. The Government’s “interference” in the private markets by borrowing and spending $3 trillion over the last two years – more than 9% of GDP annualized – is an attempt to “paper over” the insolvency of private actors in the markets – both borrowers and creditors.

These acts of interference did lead to a huge stock market rally, but just as with all forms of cooking the books they are false dawns and false hopes. They present a picture of “solvency” that does not actually exist. They present a picture of private demand in the economy that does not actually exist.

Since we are now below the “zero line” of GDP-contribution from further debt issuance we simply tighten the monetary flat spin by trying to further print or deficit spend.

The chart in the above link has been updated, of course. It now looks like this:

Despite all the printing, despite all the borrow-and-spend politics each new dollar of currency is representing a decreasing monetary velocity multiplier – that is, we now get less than one dollar for each dollar – the real rate of return is now NEGATIVE.

As in a flat spin in an aircraft, you cannot pull up and live. All pulling up does (printing or borrowing more money) is tighten the spiral. I identified this crossover in December of 2008, and warned of it months earlier.

We have tried it Bernanke, Paulson and Geithner’s way and it has failed.

We will strike the ground unless immediate corrective action – that is, pushing forward on the stick – occurs.

Taking that corrective action will cause us to lose altitude faster for a while. If we wait until the ground is “too close”, we will strike the ground and (economically) die. The precise point where there is no longer enough time (altitude) is not known in advance, but that we have far less margin now, more than a year later, than we did in December of 2008 is a mathematical fact.

To halt this process we must take the following actions now:

1. All direct taxes must be scrapped immediately. This means implementation of something like The Fair Tax. I fully understand the political ramifications of thousands of lobbying firms and individuals losing their ability to game tax code, and why this sort of reform is unpopular with the political class. Politics must give way to mathematics; the government must align its revenue with the promulgation of actual business success as measured by actual consumer final demand. In addition such a change, while radical, would cause an immediate rush into America for the world’s business headquarter locations, and with those businesses would come high-paying executive, administrative and manufacturing jobs. This proposal is an actual bill (HR. 25 / S. 296) which means it can be moved and passed. We just need the political will to do so.
2. ALL government support for insoluble debt must be removed. This means restoring mark-to-market, barring all off-balance-sheet activities and deeming that loans such as HELOCs behind underwater, non-performing firsts be written to recovery value (which in most cases is in fact zero.) I understand that this will expose the existing insolvency of some very large financial institutions. I also understand this is very politically unpopular for obvious reasons. It does not matter; this has to be done.
3. Banks must be required to hold Capital Reserves equal to 10% of their outstanding assets that are secured and 100% against all unsecured loans. This will cause even more insolvencies, but it will instantly clean up the banking system. Provide a six month time period for all institutions to come into compliance with (2) and (3), with no extensions, and mandate that any firm that does business in the US must comply – no exceptions. Going forward the 10% capitalization level (for secured assets) must be monitored and maintained as a “warning level” and firms must be liquidated at 6%. This will guarantee in the future that the FDIC will never a take a loss on the deposit insurance fund.
4. Treasury must then use the existing authority under The Constitution to issue non-debt-backed dollars. This does not require new legislative authority – all existing coins are in fact not debt-backed! Treasury can thus issue fiat, non-debt-backed currency under existing authority – it has simply refused to do so! This use should be restricted to funding FDIC pay-out requirements for the firms that become insolvent under this reform process. This issuance – if limited to FDIC payout coverage – will not be inflationary as it will exactly balance the deflationary force of default on the debt caused by those insolvencies.
5. An expedited, one-time bankruptcy provision must be made available to consumers so they can enter and process against an expedited Chapter 7 liquidation. It is essential that we permit consumers to de-leverage back to sustainable levels. Points #2-4 will insure that banks that fail as a consequence will have their depositors covered.
6. Credit-Default Swaps – or any other form of derivative – must be forbidden unless exchange-traded with a central clearing and margining counterparty that exposes all information to the market, including bid, offer, size and open interest. That counterparty must be the buyer for all sellers and the seller for all buyers, as is done today by the CFTC and OCC. Those firms that cannot post cash margin against their open, underwater positions must tear them up within 180 days. Speculation is fine – provided you can prove you can clear the trade! Again, any firm that wishes to do business in The United States must comply in all markets, or be barred from our markets. Once again this may produce insolvencies but point #4 will (again) guarantee that all depositor guarantees are covered.

Government is enacting “health care reform” today not to reform health care, not to provide health care, but rather to impose an immediate tax on all Americans to attempt to pull up even harder on the monetary stick.

It won’t work folks. It can’t work. More than 18 months ago I identified the primary failure in the path that was being taken, and why. We have tried it Bernanke, Paulson, Geithner, President Bush and President Obama’s way now for nearly three years, and yet there has been no resolution of the debt problem, no resolution of the housing market and no actual economic growth. Instead we have papered over insolvency and lied about the health of both our banking and economic systems.

Meanwhile the cracks in the dam continue to grow. Greece is not just “one little problem” over in Europe. Behind Greece is Spain, Portugal, Italy, Ireland and even Great Britain. None of these nations have yet taken the actions necessary to resolve the problem, for the same reason we have not – it is politically very difficult to tell the entrenched banking interests “you must eat your own cooking – even if you choke on it.”

We still have time to choose between bad and horrifically awful. We can choose between recognizing the Depression we are already in (private GDP has contracted by more than 10% from the peak, which is the definition of economic Depression) or we can risk Zombieland or Mad Max becoming reality.

Since Europe and the rest of the world show no desire or expectation to do the right thing, we must either firewall ourselves off from their collapse or we will inevitably go down the bowl with them.

We are risking severe civil unrest and the possible destruction of our republic by our continued refusal to face the mathematical facts, not just a “double dip” recession. What Greece and other nations are seeing now is nothing compared to what is on the horizon and will reach us if we do not act.

Mathematics yield to no political desire or arrogance wielded by man or woman. Those relationships described by mathematics inexorably come to pass, unless you change the equations. In a debt-backed fiat currency world continuing to load debt into a system that has too much debt in it related to production is a futile and self-destructive act, just as is an alcoholic deciding to chug yet another bottle of whiskey.

Economically we are facing liver failure and brain cancer unless we stop gorging on our drug of choice – debt. Whether the consequence of ceasing to do so is politically expedient or not is, at this point, immaterial. We are literally gambling with the ability of this nation to continue forward as a going and peaceful, civil concern.

We still have time to act and do the right thing to halt what will befall us should we continue on our present path, but that time is running out.