It’s Time to Finally be Fearful and Take Note

Friday, 26 Oct 2012 08:36 AM

By Jacob Wolinsky

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As I noted several weeks ago, it is time for investors to get fearful. Over the past few weeks, we have had some of the worst market declines of the year, and the Standard & Poor’s 500 is down over 3 percent in the past five days.

What happened?

Earnings season kicked off. Wall Street and companies give guidance below what they actually think earnings will be, and therefore, the companies almost always beat expectations. If even 51 percent of companies miss estimates, it is nothing short of a miracle.

According to Factset, only 42 percent of companies have reported sales above estimates so far this quarter. This percentage is well below the average of 55 percent recorded over the past four quarters. Why did this happen?

Like politicians, companies always like to find excuses. There are always plenty of excuses, but the global economy is slowing, and analysts and investors did not look at that issue. Asia faces huge problems, and the Eurozone is still a big mess.

However, another event occurred — reversion to mean. Throughout the past few years, companies have been saving every penny to try and squeeze out higher earnings. Profit margins were at the highest level in years. But this trend could only last so long. Profit margins are starting to come down. Therefore, even if companies were reporting strong sales, the total earnings would be lower. As mentioned above, however, even sales (the top line) are suffering due to Europe and Asia.

Another issue is finally being accounted for, albeit slightly late. The fiscal cliff is coming up on Jan. 1. The fiscal cliff is a combination of tax increases and spending cuts, which economists across the political spectrum agree will cause real harm to the economy.

Usually the market discounts macro issues many months in advance. However, investors seemed to think the cliff cannot happen, and ignored the issue. Now as the issue comes closer, and President Barack Obama refuses to back down on his pledge to implement tax increases, the market is getting worried.

CEOs from across the political aisle are also worrying about this issue. Larry Fink, CEO of BlackRock, the largest asset-management firm in the world, stated on Thursday that the “most important issue affecting the next president will be how they deal with the fiscal cliff, and not one question from one of the (debate) interviewers ... was how are you going to deal with that."

The market is finally starting to get scared. This is a healthy sign. The market should not ignore big issues such as the fiscal cliff. Whether stocks will go up from here, no one knows. But the market seems to be just beginning to realize the magnitude of problems ahead.

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