Weekly Marketmail

Rising Earnings Finally Lift Wall Street's Mood
By Louis Navellier

Last week, Wall Street finally started responding to higher earnings! The S&P 500 rose 3.55% last week; the Russell 2000 rose 6.6%, and both the Dow and NASDAQ reached break-even, year-to-date. On the earnings front, UPS' better-than-expected earnings and positive outlook suggested that commerce may be picking up. Then, Ford's report of strong sales and earnings included a plan to be debt-free by the end of 2011! In fact, earnings were so good that Wall Street ignored some softening economic news on housing starts, new home sales, leading economic indicators and new jobless claims. Stocks are also up due to robust global growth: Asia is growing fast, Europe is recovering and a weak dollar is lifting U.S. exports.

European Economies Surprise the Skeptics

Last week, we learned that the British economy grew at its fastest pace in over four years, with a 1.1% rise in second-quarter GDP, much stronger than economists' consensus estimate of a 0.6% rise. Also, Germany's Ifo business sentiment survey surged to 106.2 in July, up from 101.8 in June. Economists had expected a sentiment decline in July, so this surge shocked the pundits. In a similar surprise, the ISAE Italian consumer confidence index rose to 105.6 for July, vs. a revised 104.5 for June and an analysts' consensus forecast of just 103.9. For icing on the cake, Europe aced its banking "stress test" on Friday: Only 7 of 91 banks (5 of them in Spain) failed to survive the "worst imaginable" scenario.

This is an amazing turnaround for a continent that had been relegated to the economic trash heap last Spring, due to riots in Greece and troubles in Spain. The continent once maligned as "socialist" has re-embraced government austerity as the old-fashioned solution to its debt problems. Despite recent credit downgrades in both Ireland and Portugal, the euro has soared lately - defying the skeptics once again.

There's another reason why Europe is happy these days. There's only one week left in July! I must admit that my European friends tell me that sentiment tends to be on the rise in late July, since August is right around the corner and many Europeans take their traditional month-long vacation in August!

Maybe the European Central Bank (ECB) President, Jean-Claude Trichet, is entitled to a little crowing. In a Financial Times article on Thursday, he said that public spending cuts and tax increases should be imposed immediately throughout the industrialized world. Trichet argued that policymakers who want to keep "stimulating" (i.e., running higher deficits) are mistaken. He said that cutting borrowing would not hinder growth. Trichet also took a shot at the Obama Administration and the International Monetary Fund (IMF) by criticizing the results of their 2009 push for budgetary stimulus, saying, "With the benefit of hindsight, we see how unfortunate was the oversimplified message of fiscal stimulus given to all the industrial economies under the motto: 'stimulate', 'activate', 'spend.'" It is highly unusual for the ECB to criticize U.S. policies, but Trichet is clearly emboldened by the success of Europe's austerity programs.

Meanwhile, the U.S. Increases its Deficit Projections

Turning a deaf ear to Europe's pleas, the White House raised its forecast Friday for the fiscal 2011 federal budget deficit to $1.4 trillion, or about 9.2% of GDP, up from its previous projection of $1.267 trillion. Not only are the federal budget deficits for 2009, 2010 and 2011 well above $1 trillion, but the White House is projecting $8.5 trillion of additional debt over the next decade. Also, the White House expects the U.S. unemployment rate to only decline to 8.1% by 2012. This is after saying (last year) that the 2009 stimulus (spending) package would help keep the jobless rate below 8% for the foreseeable future.

The White House budget office's higher projected deficit numbers reflect the expected impact of the new healthcare law, the financial-regulation bill, the new student loan laws and other measures enacted since the fiscal 2011 budget was first drafted. Ironically, the White House budget office said the healthcare law, which was initially promised to cut deficits (or at least be budget-neutral), is expected to add $51 billion in debts from 2010 to fiscal 2012 - even before the plan takes full effect. While Europe prospers, despite austerity cuts, the U.S. is continuing to add new federal programs to balloon our deficits further.

Last Wednesday, Federal Reserve Chairman Ben Bernanke told Congress that plans for further easing were still in the preliminary phase. Bernanke also told Congress that the economic outlook remains "unusually uncertain" and that he saw no immediate relief for the weak job market. Wall Street sold stocks on the assumption that the Fed was running out of policy bullets to stimulate the U.S. economy.

However, Chairman Bernanke must have slept well Wednesday night, because he said on Thursday that the Fed was "ready to take further steps" to stimulate the U.S. economy if growth turns out to be weaker than expected. This seemed to reassure Wall Street, as the S&P 500 rose by 2.25% on Thursday. Also, since the Fed promised to keep interest rates extra low for an extended period of time, stocks will appear more attractive, since investors are increasingly getting frustrated with earning near-zero interest rates.

Corporate Debt Redeemed at a Record Rate

Speaking of low interest rates, another reason that Wall Street will focus more on stocks than bonds is that corporate debt is now being redeemed at a record rate. Corporations are awash with record levels of excess cash, so they are buying back their expensive debt offerings. I recently joined a conference call with a large client who was very frustrated that his high-yield bonds (mostly BB- and B-rated) were being redeemed at an incredible rate. This client also owns some Ford bonds that will apparently be redeemed by the end of 2011, according to Ford's Friday announcement that they will be "debt-free" next year.

Another reason that investors may want to focus more on stocks than bonds is that Treasury Secretary Tim Geithner confirmed that the Obama Administration will allow the 2003 tax cuts for the wealthiest Americans to expire at the end of 2010, despite calls from an increasingly vocal group of Democrats to delay any tax increases. Specifically, Geithner said the White House would allow taxes on top earners to increase on January 1, 2011, as part of an effort to help bring down the mounting federal budget deficit.

However, in 2011 the Obama Administration might need to deal with a dramatically different Congress, in the wake of mid-term elections in November. Was last Thursday's stock market surge the start of the traditional mid-term election rally? I feel that the real trigger point for the stock market could be the July payroll report, to be released on Friday, August 6. This report is likely to show substantial job losses in government, due to the layoffs of Census workers and other government jobs, but if private payrolls top June's 83,000 pace, Wall Street may like the fact that the private sector is once again adding new jobs.

With the Congress now on their summer recess and obsessed with the upcoming elections, the U.S. stock market traditionally tends to cheer up in August. About the only thing that I can see derailing the stock market rally is if the upcoming July payroll report comes in worse-than-expected on Friday, August 6.

I'll bring you more market news in the next Market Mail, Monday, August 2. Have a great week!