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A Closer Look at Recent Upbeat Earnings Announcements – Don’t Believe the Hype

April 17, 2008 –

On April 15th, the U.S. markets rallied, with the DJIA adding more than 250 points (2.08%) and the S&P 500 adding more than 30 points (2.27%). Of course, this brought out the mandatory Wall Street cheerleaders and numerous stories that FINALLY, it appears that the U.S. markets are starting to turn the corner. As could be expected, other major global markets with close ties to the U.S. markets followed suit the following day as they also rallied by about 2% or more. Numerous stories appeared in the media extolling the resiliency of global stock markets and the “upbeat” earnings of U.S. companies that propelled this big one-day rally. Stories soon followed of “super-cycle” bull markets in the U.S. still being intact, and that this one-day rally is the impetus that would propel the U.S. DJIA to 14,000 or possibly even 16,000 points and take the rest of the global stock markets along for the ride. My response? Don’t believe the hype.

If we take a closer look at the headlines that sung the praises of “upbeat” earnings of U.S. companies such as J.P. Morgan, Intel, and Wells Fargo, we’ll discover that the word “upbeat” has been changed in meaning. “Upbeat” in the financial world does not conform to the Webster dictionary definition of “cheerful”, and “optimistic”, but instead has been distorted to mean “bad, but not as bad as the expectations that have been carefully created and molded by CEOs just prior to earnings releases so that earnings can beat expectations”. Even then, this modified definition of upbeat for the expediency of the financial industry may not stand the test of time as most companies still seem to be less than forthcoming about the problems that continue to plague their companies and the overarching economy.

JP Morgan’s 1st Quarter 2008 profits were cut in half from a year prior, and in fact would have been cut by about 80% were it not for the approximate $1.36 billion they received from the 1st Quarter 2008 Visa IPO. Yet, no one seemed to care that if you backed out this non-recurring one-time gain for JP Morgan, their profits would have fallen by 80%. The sentiment on Wall Street was, “at least, they’re not losing money.” Thus, despite the less than cheerful and optimistic earnings report, JP Morgan’s earnings release was reported in large part by the financial media to be an upbeat earnings release, and their shares rallied by almost 7% in intra-day trading. Makes you wonder what companies own the mainstream financial media if they are producing headlines calling such earnings reports “upbeat”. Similar arguments could be applied to both Wells Fargo’s and Intel’s earnings press releases as well.

Many stories that circulated in the press regarding Intel’s earnings carried key statements such as the following: “Intel defied predictions by posting 17 percent growth in the Americas last quarter,” yet failed to mention that despite this growth in the Americas, their earnings for the 1st quarter still dropped on a year-to-year basis. In addition, many financial journalists praised the fact that Intel’s sales forecast topped analysts’ estimates. Voila! We have share price appreciation for Intel. Are you kidding me? The Intel CEO played analysts like a finely tuned violin by implementing the following formula: Undercut expectations of analysts with gloomy reports a couple of weeks before your earnings announcement, manufacture a systemic downgrade in analysts’ expectations, and then surprise them with poor earnings that beat your manufactured especially gloomy outlook.

Then after the aforementioned has been accomplished, wow the thundering sheep herd with declarations of robust future sales forecasts. Short—term bumps higher in ailing stock markets, and even week long rallies, are most often based upon perception and games that are played to fool investors versus solid fundamental economic health. I’ll explain later in this article how the U.S. Federal Reserve is the biggest contributor to this game by creating illusory wealth among investors that isn’t even real due to their highly inflationary monetary bailout plan.

Here are just some of the warning signals that are still being hidden from the public by the sales-driven commercial investment industry:

(1) The U.S. Comptroller General David Walker’s resignation last month in March of 2008, fueled in part by his frustration regarding his repeatedly ignored warnings to Congress that they must cut their deficit spending. Remember, it was former U.S. Federal Reserve Chairman Alan Greenspan himself who made the comment that “Deficit spending is simply a scheme for the confiscation of wealth.”

(2) The obvious conflict of interest regarding the valuation of massive amounts of complex financial derivatives held on the books of many major global financial corporations. By the way, the global derivative market capitalization is at least ten times as large as the global stock market capitalization. Think of the consequences on global stock markets if just 10%, or even 5%, of the derivatives markets imploded. Many difficult to mark and illiquid financial instruments are currently valued by internal valuation models developed by management executives whose annual bonuses depend on the valuation of the very derivatives they are asked to value. Who really knows if the books of many major financial institutions are really as solid as the picture they present to the public? One must take their word as truth because it is their very earnings announcements that are driving stocks higher in the short-term right now.

As firms like Merrill Lynch have declared massive multi-billion dollar write downs time and time again after declaring that they have declared all the toxic waste on their books, are you really comfortable trusting the word of these executives? I would say that there is an extremely high probability that they are still being less than forthcoming about the true state of their affairs.

(3) The reason for my skepticism above is not only driven by the conflict of interest regarding valuation models, but also due to the fact that the credit rating system in America is a total sham (the reason for this is beyond the scope of this article but the conflict of interest in the credit rating system is well documented to date). Consequently, with quite likely trillions of derivative products backed by financial instruments that are incorrectly rated due to profit-motivated relationships fraught with conflict of interests, when the time comes to actually sell them on the open market, another round of massive write downs is very likely on the way.

(4) There has not been one credible, sustainable solution implemented by the U.S. Federal Reserve or any other Central Bank in response to this grave toxic mix of Credit Default Swaps, Collateralized Debt Obligations, faulty credit ratings, and bad mortgages that are still festering in the global financial system. Every solution thus implemented has only involved the devaluation of currency (and subsequent inflation) or a charade where bad money is temporarily swapped for good money and then later re-introduced into the system after “stability” has been manufactured. Someone please tell me how trying to hide risk, instead of removing it from the system, or inflating currency until kingdom come will solve the problems of risk that still exist in the global financial system?

The last time the U.S. Federal Reserve took the rapid inflationary approach to head off a deep recession was after the dot com crash hit U.S. stock markets in March of 2000. A real estate bubble in the U.S. was artificially manufactured courtesy of the U.S. Feds solely to avoid a deep recession. On many levels, that plan failed, not only because their inflationary monetary policy was directly responsible for creating the housing crisis in the U.S. today, but also because the real estate “wealth” they created to ease the pain of stock market losses was merely illusory and very far from real (I’ll explain below).

In conclusion, there is no doubt that the U.S. Federal Reserve will try to inflate their way out of this problem just as they inflated their way out of the March, 2000 dot com crash by slashing interest rates an unprecedented 12 times in a row. The only problem with this strategy today is that with the Fed Funds rate already sits at 2.25%. Even if by some miracle, they are able to turnaround U.S. stock markets and thus, global stock markets, with their monetary inflation policy, will any investor in traditional markets really benefit? Remember, all major fiat currencies will likely devalue this year due to worldwide inflationary policies that are currently being implemented.

[tags]INTC,WFC,JPM,financial crisis,bear market[/tags]

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