Q4 GDP Shrinks by 3.8%

The economy posted its steepest decline in 27 years, shrinking by 3.8% in the last quarter of 2008.  Still, it was better than expected 5.4% drop.

The markets interpreted these news in an interesting way, deciding that a relatively mild decline in GDP signals that more drops are on the way, pushing the recovery further in the future.  I wonder whether the markets would have been happier if, for example, the GDP dropped 7% last quarter?  It seems that all kinds of news tend to be interpreted negatively these days.

Netflix Reports Excellent Earnings

Recession appears to be beneficial for Netflix.  Indeed, it remains one of the few companies holding up remarkably well during the past year as consumers are apparently unwilling to cut down on inexpensive entertainment that the company provides; in fact, using company services more instead of going to movie theaters.  Yesterday, Netflix reported earnings that easily beat Wall Street expectations, and upped the outlook for the next quarter and the full year as well.  This MarketWatch article discusses its quarterly results in detail.

The “net” in the company name is getting traction.  Netflix shied away from making its own branded boxes, instead striking partnerships with DVD, TV, and console manufacturers.  That’s a very clever strategy as it allows the company to concentrate on its strengths rather than get involved in hardware manufacturing where it has no experience.  At present,  DVD players made by LG and Samsung, as well as X-Box player now offer Netflix streaming, with more Netflix-ready devices on the way.

Netflix name could well get synonymous with video streaming.  While it doesn’t yet charge for this service, it will undoubtedly do so in the future, increasing revenues and becoming a truly international company overnight.

Dow 4,000

In my previous post, I wrote about disparity of reports for the PE ratio of overall market, which range from 10 to 19.5.

Armed with high version of the PE ratio, some commentators state that the market is still overvalued, since PE at historic market bottoms (such as in 1970’s) tends to be just under 10.   To get to that valuation, they contend that market may well fall another 50% from the current levels.  Optimists counter that current PE ratio (whatever it may be) is inflated by bank losses, and by the fact that extremely low interest rates justify higher stock valuations.

Can the market drop another 50%?  Certainly, stranger things have happened before.  But I don’t think it is likely.  The abundance of pessimistic articles like this typically points to a market nearing its bottom.  For more discussion on this subject, take a look at this article from the Motley Fool.

What is Market’s PE ratio?

It would seem that PE ratio for the overall market should be readily available, as it is one of the basic stock valuation tools.  Yet, amazingly enough, prominent financial site show strikingly different results.

For example, according to Yahoo!, S&P 500 PE ratio stands just over 10.  However, official Standard and Poors site quotes 19.5!  I then tried to look up Dow Jones Industrial average ratios.  Here, Yahoo! and Dow Jones sites are in agreement, showing 10 — that same ratio for S&P reported by Yahoo! for S&P 500, with the side note that companies with losses were excluded from calculation.  It makes quite a difference, especially now — huge write-offs by financials skew overall ratio higher.  If losses are included in calculation, Dow Jones site reports PE of 13.

I don’t want to take sides on who is right here.  I know exact PE ratios of stocks in my portfolio, and that is far more important than that of the overall market.  A valuation of any index depends on the stocks that comprise the index, not the other way around.  This simple truth often tends to be forgotten.

Tech Company Earnings

The earnings season is in full swing, and this week five technology titans reported their fourth quarter results, and they were decidedly mixed.  On the negative side, Microsoft and Ebay reported lackluster results, and predicted further slowdown ahead.  However, IBM, Apple, and Google soundly beat estimates.

The market, as it has done over the last year, again chose to be pessimistic and concentrated on the negative, interpreting Microsoft’s results as an indicator for the whole industry.  But is it justified?  Both Ebay and Microsoft have had its own specific problems over last few years that are not related to the overall economy.  Microsoft, for example, has been losing mind and market share to Apple for quite some time.

Yet Another Bush Legacy

According to an article in Marketwatch, stock market declined at annualized rate of 2.3% during 8 years of George W. Bush presidency.  He is the first president out of the last five to oversee any decline at all.

The first day of Obama presidency did not impress the market, either.  Yesterday, the market fell by some 332 points for the worst performance of the year, as well as the worst performance of the Inauguration Day in history.

It looks like the Obama rally that many were hoping for in early January did not materialize.  We are in the beginning stages of the earnings season, and earnings, and especially outlooks for the next quarter, will be driving the market.

L, U, or V?

Everyone is in consensus that at some point this downturn will end, and a recovery will begin.  But what kind of recovery will it be?  The pessimists maintain that we will bounce along at the current economic levels for quite some time, resembling the letter “L”, in fact with no meaningful recovery in sight.  Another school of thought points to a recovery late this year or in 2010, as in the letter “U”.  And optimists hope for a quick turnaround, or a “V”-shaped recovery.

This article from CNN Money says that some economists believe that a “V”-shaped recovery is likely.   The reason is that the current downturn has been so sharp, and production cut so drastically, the pent-up demand that is building up right now will lead to a strong rebound in economic activity.

Nvidia’s Warning

Today, graphics chip maker Nvidia (NVDA) warned that its fourth quarter revenue will decline sequentially by nearly 50%, much worse than 6% drop expected by analysts. To call this development horrible does not do its justice. Under normal circumstances, a high-tech company that issues a warning like this will see its stock plunge.

Today, however, Nvidia’s share actually rose a few cents. Often, when a stock fails to drop in the face of bad news indicates that such news are already priced in (indeed, Nvidia’s shares are now worth about a quarter of what they were going for a year ago), and further declines are not likely. I believe this is indicative not only of Nvidia, but of many other companies in high tech sector. Intel’s warning a few days ago also had little effect on its stock.

It Is Going to Get Worse before It Gets Better

It is becoming increasingly clear that the economic situation continues to deteriorate.  A recent worse than expected job report showed that the unemployment rate shot up to 7.2%.  We had negative earnings pre-announcements from industry bellwethers, such as Intel and Time Warner.  Today, Alcoa reported fourth quarter earnings that were worse than analysts’ estimates.

This time of year marks the beginning of the earnings season, and all indications are that it is going to be quite dismal.  Investors, however, are anticipating this, and the question is whether the earnings will be even worse than already low expectations.   The current estimates are for 1% decline from a year go.  As recently as last October, analysts were expecting nearly 50% rise!

It is quite obvious that the economic situation is going to get worse before it gets better.  The market is likely to bounce around until a clearer picture emerges.  A retest of Novembers lows is possible.

Piles of Cash on Sidelines

According to Merrill Lynch analyst, “cash on bank balance sheet has tripled in the last two months to the level of over $800 billion.”  This is collaborated by the article from Bloomberg, which states that the total amount held in cash, bank deposit, and money-market funds now equals 74% of the total market capitalization.  This is the highest ratio in nearly 20 years.  Once confidence returns, this cash will find its way back into the market and will help to fuel a strong rally.