Monday, November 2, 2009

When Analysts Get it Right, They Might be Wrong

If you were to open your third quarter statements, and I hope that you do, you will find that your balance in your retirement plans has jumped significantly from its lows from the year ending 2008. This would, to the untrained eye, point to a recovery led by the stock market.

And the stock market has recovered - to a degree. Yet, expecting this to reflect into the economy that we experience day in and day out, is not there. And may not be for months. Why is this?

The Norm
When markets recover from their bottom, they do so based on what many of us like to feel is a fundamental improvement in the businesses that our retirement plans invest in. Those businesses offer forecasts to analysts who in turn predict how what the company expects its future to be, how they plan on growing or simply maintaining market share, and how they see the consumer's reaction to their efforts.

These analysts then parse this information. In doing so, they offer clients of their firm an outlook on what these companies are most likely to do and whether their positions reflect the strategy. Using terms such as overweight (meaning that more of a particular company's stock should be owned relative to their total portfolio), underweight (a suggestion that exposure to the stock should be had but not so much so that it could jeopardize the overall holdings), neutral (a reference to keeping a company's stock would neither hurt or benefit the client any better than if they didn't own the company at all, suggesting that it be balanced based on a variety of measures such as overall risk) and of course the buy/sell that signals you should, if your were a client to move in a specific direction regardless of your current position.

For the most part, analysts have been right about the stock market. Of the 344 companies that have reported their earnings so far, 85% have handily beat expectations that these analysts have reported. Is it simply the result of a command performance or is it the result of pessimistic outlooks provided these folks?

In all likelihood, it is the later. Businesses have begun to recover but are doing so without the help of the workers they would have needed in the past. Taking advantage of extremely low rates for borrowing, they have shored up their books to give the appearance of profitability, they have cut costs across their businesses and have done so without hiring workers to meet demand.

Better is Not Best
This cash hoarding has done wonders for the balance sheet. In fact, Standard and Poors company has found that the industrial companies in its index of the 500 largest cap companies has increased to by $684 billion as of June 30th. Using low interest lows to refinance debt is not the same as using low interest money to increase spending. This is also reflective in the ratings many corporate bonds have received, driving the risk of default lower.

And this is driving your retirement plan balances higher as a result. The question is: can it go on? The short answer is yes. The analysts are still giving investors false hope with lower estimates of performance in the near-term. Even without domestic hiring, companies are beginning to expand overseas. Labor is cheaper and many see the demand for consumer goods increasing offshore at a faster pace than here at home.

The long answer is no, it can't go on indefinitely. The American economy is still driven by consumers. How much of it will be in the future remains tied to the ability to borrow (still low despite the historic low rates available to even the smallest borrower, although with higher than expected requirements to access that credit remain problematic), the unemployment rate (which is expected to top the 10% mark, with even more people dropping form the ranks of the measured as their search for employment simply stops being recorded), and the bottoming of overall prices (a relative measure of how well a company can sustain profitability in the face of lower overall sales).

The Better Idea
For now, staying invested seems like a better idea than not. The problem is whether the economy's recalcitrant attitude will prevail over the business plans and the analyst's forecast. You can expect mid-caps to remain a focus in the coming months as small caps still struggle with funding their operations. Many in this space rely on research and development money to stay on track and some even look to the merger and acquisition markets to help. Neither seems very promising at the present.

Does that mean we are headed for another correction? Yes and no. Yes, we will see some result of the weak dollar having a negative effect on our investments, both equities and fixed income. No, in that it will not be as bad as the one we just experienced. The only way to take advantage of this volatility is to stay invested and doing so in a steady stream of contributions, the way your 401(k) provides, will end up in a better result than following the gyrations of the market that are bound to take place.

Paul Petillo is the Managing Editor of the and a fellow Boomer.

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