GuruVision: The Economy's Impact on Stocks Is Overrated

Whose Slowdown Is It, Anyway?

SAN FRANCISCO -- "Everybody" knows the economy is slowing. And "everybody" knows it is going to rebound in the second half of the year, providing a boost to corporate earnings. Reflecting the current profit malaise, Cisco CSCO reported earnings and revenue slightly below expectations after the close today.

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Expectation for future economic recovery fueled by Federal Reserve easing is the primary reason investors are currently acting more bullish. Such sentiments were evident in early trading today, but stocks faded toward the close. Once as high as 11,035.14, the Dow Industrials closed off 0.1% to 10,957.42, while the S&P 500 shed 0.2% to 1352.26, after trading as high as 1363.48. The Nasdaq Composite climbed 0.8% to 2664.49, but closed off its intraday best of 2705.59.

In keeping with this column's mission of challenging conventional wisdom, tonight we examine not so much assumptions about the economy itself, but to what degree economic activity really matters to equity investors. It's not as important as you think, according to two of Wall Street's most bullish gurus: Merrill Lynch U.S. investment strategist Christine Callies and Edward Kerschner, chief global strategist at UBS Warburg.

"Fed policy is the single most important catalyst for share price behavior because the Fed is the only body whose actions can directly encourage cash to rotate into equities," Callies wrote in a report yesterday. "By comparison, corporate announcements and analyst revisions are transient pluses and minuses."

A worsening economy has not caused stock prices to drop unless the Fed was tightening at the same time, she added.

Don't fight the Fed, in other words.

In a separate report released Sunday, Kerschner reached a similar conclusion about the economy's impact on stock prices, recalling that equities bottomed in October 1990 and rose 27% by March 1991, although the National Bureau of Economic Research (NBER) later reported a recession began in July 1990 and didn't end until March 1991.

Echoing the "classic" Bill Murray vehicle Meatballs, Kerschner points out that GDP "just doesn't matter" when it comes to stock prices. All that matters are earnings.

"Investing based upon any short-term judgment on the economy is risky, in that the state of the economy is not only difficult to estimate, it is also difficult to measure -- even years after the fact," he wrote.

For example, fourth-quarter GDP, which an advance report last Wednesday put at 1.4%, could ultimately prove to be negative 1.4% or up 4.4% after myriad revisions are eventually completed, Kerschner wrote.

Meanwhile, Kerschner noted even such lauded observers as Federal Reserve chairman Alan Greenspan "have a hard time figuring out what exactly is going on in the economy," (again making me wonder why he's held in such astronomical esteem). In June 1990, just one month before the NBER later declared the recession began, the chairman testified before the Senate Banking Committee that "all things considered, continued modest economic growth remains the most likely outcome," the strategist recalled.

As for the current earnings reporting season, Chuck Hill, director of research at First Call/Thomson Financial, said today that energy, utilities and health care continue to have the top earnings trends, both in terms of besting fourth-quarter results and receiving upward revisions for 2001. Beyond those three sectors, first-half estimates are in free-fall, he said, particularly in technology, consumer cyclicals and basic materials. Hill noted expectations are now for tech earnings to be flat in the third quarter vs. expectations for 11% growth back on Jan. 1.

Kerschner didn't directly address earnings for specific sectors, other than stating "with the world economy in good shape and secular demand for high-tech equipment fundamentally strong, [the] inventory correction should be over fairly soon." (That was prior to Cisco's report, I'll note.)

Still, UBS is predicting flat earnings for the S&P 500 in 2001 at $57 a share, a forecast predicated on "double-digit growth" in the fourth quarter. Looking ahead further, the Fed's commitment to avoid recession plus the Bush administration's tax-cutting initiatives augur "easy comparisons" and double-digit earnings growth in 2002, Kerschner concluded.

But if earnings are all that matter, his projections for 2001 don't support the argument the current environment is "one of the five most attractive opportunities of the past 20 years," as the strategist recently declared. Unless, of course, investors are already looking ahead to 2002's results, about which even Kerschner conceded it's "premature" to speculate.

Kerschner was unavailable for additional comment.

Meanwhile, Callies dubbed consumer cyclicals her top pick. That's consistent with her theory, in contrast to Kerschner's view, that less earnings growth is actually preferable for those long. Since 1970, "average quarterly gains in the S&P 500 index were much stronger -- at 7.5% -- when profit growth was sharply negative," she noted. "The stronger the profit growth, the smaller the gains in equities."

Her specific recommendations included retailers Ethan Allen ETH, Home Depot HD, Talbots TLB and Wal-Mart WMT, as well as lodging/gaming names Harrah's Entertainment HET and MGM Mirage MGG. (Merrill has done underwriting for MGM.)

Don't Shoot the Messenger

As reported last week, some believe the recession "hysteria" is just that. Simultaneously, a debate has arisen over who's to blame for the nation's current recession obsession.

Among others, Cantor Fitzgerald strategist and RealMoney.com contributor Bill Meehan has repeatedly put the finger right on the media.

In a conversation today, Meehan made a salient point about how, following the resolution of the election, news organizations needed "another story" to keep readers and viewers tuned in. What better way than with fear-raising stories about economic recession and layoffs, he mused.

I agree the recession talk is overblown, but wholeheartedly disagree with the blame-the-media approach. Generally speaking, reporters don't create the news. If anyone deserves blame it is Bush administration officials -- namely Vice President Dick Cheney -- for repeatedly "promoting" the slowdown, particularly when the election was still in doubt during the holiday shopping season. Economists rushing to be the first to "call" the recession, as well as Alan Greenspan for his recent "zero growth" comment are also culpable -- more so than the press in my opinion.

But I'm a reporter and a Democrat, so my biases are clear. What do you think?

The Recession Talk: Who's To Blame? Nattering nabobs of negativism - a.k.a., the press. Cheney, Bush, Greenspan and the pundits. All of the above. No blame necessary because the recession is real.

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