Friday, 24 July 2009

Macro-Level Trends – H209 Outlook – False Prophets of a False Dawn

Q2/H1 Reporting season is upon us and the general 'not so bad as expected' news appears has lifted markets spirits. No where near the 'animalistic spirits' that drive the market in ordinary times but still apparent cautious optimism.

Yet the 10 day rally period seen across US, Euro and Asia to date sits within the broader context of liquidity constraint – thus trader (not necessarily purist investor) behavior seems to be charging the markets; jumping on any positive signal - no matter how thin – and trading sentiment and volatility instead of fundamentals. Thus we find ourselves in a period of trader vs investor schism.

Of course behind this dynamic is the fact that cash-conscious publicly traded companies on every western exchange are desperate to be seen as investor picks; thereby able to leverage their improved MarketCap to draw financing from either directly off the balance sheet or able to better bargain with bank or bond lenders. All obviously in order to improve cash-flow conditions, working capital and so ease operating pressures both internally and on either side of their creditor-debtor chain.

Recent press has been full of the 'good-news' stories highlighting the day after day upward trending, the 8-month high of the S&P500 and analyst-beating Q2 earnings; from everyone from across the industrial board, from Coca-Cola in consumables, to e-bay in retailing, to Caterpillar in capital goods, to Xerox in IT, to Merck & Bristol-Meyers & Wyeth in pharmaceuticals, and of course (as expected) the more than buoyant results from the more sound “good” financial such as Goldman Sachs and JP Morgan, and even heavily reduced but still positive results from others like Amex.

In Autos, Hyundai as expected performed well making hay domestically (p 15% at home) and leveraging customer attraction efforts in North America at the expense of GM, Chrysler and even Toyota during this tumultuous period; also gaining from the FX effect of a weak Won. And Ford beat analyst expectations with lower than forecast losses, so demonstrating the combined effects of of internal turnaround progress, the “cash for clunkers” programme and migrational US market assistance.

Fairing less well the likes of McDonalds, UPS,Eastman Chemical, EuroTunnel, NCR, Ericssonn, Microsoft, Amazon & Hynix Semiconductor; the last of these tech and cyber-space businesses highlighting that IT and web2.0 have not been as immune as previously thought.

So a mixed bag of results. But what really lays behind the good news stories? Is there substance or are western markets creating a momentary “over-exuberance” primarily via traders and the positive overnight effect of the west-east regions?

Whilst many results have beaten gloomy analyst predictions, and are of course sector influenced (eg the 'recessionary comfort food' factor of Hershey's or the 'global stimulus gain' of Caterpillar Inc), the broad reality is surely that there is a 'counter-point-effect' taking place between continued downbeat macro-fundamental measures (ie those in recent US unemployment and UK GDP retraction) and the ability of corporate management to both take drastic restructuring steps and legitimately re-orientate accounting procedure to boost quarterly results. These could be deferring capital investment, changing inventory values via switching between FIFO to LIFO (especially under today's deflationary times), delaying supplier payments, use of 'extra-ordinaries' eg digging into the provision pot, altering capital goods' depreciation or maintaining old/better asset valuations. The options are varied and many, and during such pressured times firms are undoubtedly re-discovering such pain-relieving financial-engineering tactics.

But it must be said that investors are looking well beyond the top and bottom-line figures, just as CFA's and forensic accountants are well versed in reading the subtleties of accounts so investors are increasingly looking for YoY and QoQ like for like readability, simplicity and general transparency. The best of corporations have realised this and have over the last year or so become more detailed in their reporting, conveying more of their forward-looking business strategies when appropriate can even gain investor credibility by reducing dividends or indeed giving non-payment to demonstrate their financial prudence.

Thus the Q2 season seems marked by CEO's and CFO's continued positioning “between the devil and the deep blue sea”. Whilst the market will trade on transient good news and traders will seek to effectively arbitrage sentiment and trading volumes/patterns the longer-term independent investor must see past the white-noise of volatility and much of the rhetoric from media 'experts' and talking heads who are keen to talk-up their own holdings.

Given western economy realities the world is looking for a rebound in BRIC regions to pull the west from its mire, led by export driven western companies. These for the time being relate to infrastructure and associated sectors (eg mining, commodities and steel-processing and IT hardware and systems) and the push for further globalised (and consolidated) agriculture in China, Asia & Africa. In the medium term select western goods should gain traction again as Asian consumers loosen their discretionary spend wallets.

But it must be stated that China et al obviously seek greater gain from their rebound given their foreign reserve currency holdings and desire to own a greater portion of the global value chain, especially in natural resources, their inbound transportation and outbound transportation of export goods. For hard-pressed western companies and governments who want to ride the Chinese rebound to provide domestic commercial growth, an expanding money supply and returned consumer spending to buoy western economies that will be a hard pill to swallow.

The threat of implicit protectionism has been rising via subtle trade policy changes both in the west and Asia, but for the sake of all concerned this must be avoided. Ironically, given what seems a very deflated state of the western auto-industry, it can continue to provide an inspirational vehicle for open door trade policies and so improve international diplomacy. [NB, even if the Opel-BAIC deal looks doomed due to both German domestic political issues and the reality of BAIC trying to amalgamate the 2 very different enterprises].

Western markets need more than the present over-reaction to less than bad news. Western companies need demand pull from BRIC nations to kick-start their own corporate growth ambitions and so domestic local and national economy fortunes.

Thus the investment community whilst possibly copying their trader counterparts for near term gains, may need to undertake subtle firms of activism toward both their own company-stock interests and toward government.

Ordinarily, when the economic transmission mechanism is running smoothly and top-down (PESTEL) and bottom-up (accounting) evaluations can be made the 'efficient markets' theory has legitimacy. But today we still sit within an uncertain period, especially so given that much of the banking write-downs reportedly necessary have not taken place and so fundamentally undermines sound long-term value-creation.

The western economic engine, whilst previously saved from totally stalling, still needs attention and full comprehension of the problem and its solution. The recent rally we've could well be the result of over-charged optimism, just as a stalling engine can experience a temporary power surge from erroneous air being sucked-into the manifold from a vacuum leak. Hope/sentiment is that vacuum, and the fortuitous Q2 earnings results that erroneous rush of air.