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  Posted on: Thursday, November 13, 2008
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TARP Bailout Shifting Focus
Earnings Estimates Continue to Decline
S&P Earnings Estimates (Reported and Operating) 

   
 
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Remember that capitalism made the U.S. the greatest country on the planet.  Of course, that was when our growth came from consumers' savings providing the funds for productive investment.  Unfortunately that formula for success changed in the last couple of decades.  Under the new paradigm  we tried to maintain our superior growth with consumers' no longer saving,  but instead, using credit and funds raised from soaring asset values to maintain and improve their standard of living.  Simply put, consumers spent as much or more than they earned.   The resulting debt grew to over $53 trillion on a GDP that was less than 33% of the debt.  Until we start building up our savings in order to pay off the accumulated debt, we will continue to lose the super-power advantage we still have over the rest of the planet.  The stock market and/or the housing market were able to bail out the consumer every time there was pain.  Now that these two asset classes are no longer rising, the Fed and Treasury are attempting to come up with bailout plans that continually change, eroding investor confidence that the people in charge knew what they were doing.

 

Yesterday Secretary Paulson abandoned his original plan to buy troubled assets from financial institutions.  Although the government will continue to invest in these institutions, it will switch focus to the nations struggling consumers.  We were never big fans of buying these troubled assets so the "bait and switch" move was a good one in our opinion.

 

In fact, we stated our position on this in the weekly comment written on October 2nd this year,  titled "We Hope To Be Wrong".  We will quote from that report: "This brings us to the latest 'Wall Street Bailout'.  While the market has been rallying and declining on changes in the odds that congress will pass the Paulson plan, we think that the market will go down much further whether the bill passes or not.  After all, the plan in place, which now includes a bunch of 'add-ons', will not help an extremely serious problem very much at all and we think that investors are seeing right through the 'mirage'.  (Furthermore the market only now is waking up to the fact that the real economy is in for a hard landing in any event.) The 'Plan' only deals with the left hand side of the balance sheets (assets) of these financial companies' and leaves the right side (liabilities and equity) alone.  This means the government will buy toxic assets on the left side (assets) and leave the right side alone to fend for itself.  The bailout means that if the government pays the same or a little more for the toxic assets on their books, it will increase the cash available and decrease the toxic asset by the same amount.  This does not improve the stockholder's equity that is needed to encourage the bank to make loans and give relief for the credit crises we are in presently.  The institutions that are the weakest will sell the government their toxic assets but the increase in cash will not be enough to encourage the institution to make loans to consumers and businesses that are in desperate need for cash."

 

Actually, our position on government involvement in this mess was stated best in the special report on the left side of our home page, "How to Get Out of This Mess".  The bottom line of that report called for letting the free markets work to find a bottom without government interference.   We will quote two short paragraphs from the report, but really recommend that you read the whole report.

  "The Fed will not be successful if they try to micro-manage our economy with a secondary role in controlling inflation. In our opinion, if they continue to attempt to liquidate us out of this mess, it will only postpone the inevitable decline in house prices and lead us into a long deflationary environment such as Japan experienced starting in 1990."

"On the other hand, if they allow housing prices to decline to pre-bubble levels, this mess could be over late next year.  We have tremendous excess leverage (mostly in real estate) that must unwind without government interference for us to be able to get out of this mess!!  In our opinion, we have to let our democracy go through excesses (without extreme government interference) followed by contractions (without extreme government interference)."

Back to the present real world conditions-- sales at the nation's largest retailers (even luxury stores) fell off a cliff recently signaling that this will probably be the weakest shopping season in decades. Best Buy, the nations largest electronic retailer called the phenomenon "rapid seismic changes in consumer behavior".  And this is a retailer that just lost their main competitor, Circuit City, through bankruptcy.

Yesterday morning Bank of England Governor King was finally able to see what is going on in the world.  With industrial production in a steep decline and the unemployed rising to a 10 year high, the Bank was prepared to lower rates again even after the 1.5% surprise rate reduction last week.  He is now aware of the antonym for inflation -DEFLATION, and is prepared to prevent it.  We remember when Microsoft Word (just a couple of years ago) did not even recognize the word deflation and would underline it in red.  Germany has also just entered a technical recession today.  The global environment continues to deteriorate-and that reminds us about the comment we wrote December 22, 2005, "Softening Housing Market Puts Global Economy at Risk".

In addition, since 2005 we have been calling for the S&P 500 to decline until it reaches about 10 times or less Comstock's proprietary trendline earnings of about $70.  We have been keeping track of the earnings estimates made by the S&P analysts this year (spread sheet attached).  As you can see the estimates have been dropping non-stop all year.  Although the main earnings numbers to concentrate on are "reported" earnings and the present estimate for 2009 is just under $50, we still believe in using our smoothed trendline earnings number of about $70 and, therefore, still have the objective of around 700 on the S&P 500. We did break to new lows today before rebounding sharply, and there is good support at around 770 (the 2002 bottom). We believe the market will reach our 700 objective before the secular bear market ends. In our view the deleveraging process of the U.S. and global economies is only in the early stages and inevitably will run its course.  The most that governments can do is to prevent a systemic collapse of the financial system while the painful adjustment unfolds.  The decline in the economy is likely to be long and deep with a lot of nasty surprises still ahead.

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