- - Thursday, January 27, 2011

ANALYSIS/OPINION:

Corporate earnings came to a boil this week. The World Economic Forum kicked off in Davos, Switzerland, and the State of the Union address talked about the economy, jobs, cuts, investments and more. Add to that fresh economic data, a rate decision by the Federal Open Market Committee and another round of snow on the East Coast.

In short, it was a busy week with a smorgasbord of data to collect and decipher in your investment mosaic, all while the Dow Jones Industrial Average flirted with 12,000. I’d note this was the first time that index has reached that point since June 2008. By comparison, the S&P 500 remains below its June 2008 levels, but the Nasdaq Composite Index has soared past its, and is only a few percentage points off of its October 2007 high of 2,810.38.

In looking at those three 10-year stock charts, those indexes have rebounded rather quickly and far faster than the underlying economy. Consider that the last trough-to-peak move in the Nasdaq Composite, the S&P 500 and the Dow Jones Industrial Average spanned more than 60 months — from October 2002 to October/November 2007.

In that period, those indexes climbed just shy of 110 percent on average. By comparison, in the past 23 months, those indexes have climbed more than 94 percent on average, even though unemployment remains high, disposable income growth has been sluggish and renewed concerns over housing, inflation and job growth are on the rise.

And according to new Congressional Budget Office (CBO) estimates, the government’s deficit will hit almost $1.5 trillion and joblessness will remain above 9 percent this year, even though the economy will grow by 3.1 percent. Not to get sidetracked, but the CBO now estimates a nationwide unemployment rate of 8.2 percent on Election Day 2012.

Now let’s take a look at some of the earnings reports this season. There have been some bright spots — Apple Inc., CSX Inc., McCormick & Co., Skyworks Solutions, Netflix Inc., Qualcomm Inc. — but there have also been some weak spots. Examples of companies that either missed expectations or offered weaker-than-expected outlooks include Starbucks Corp., Motorola Mobility Holdings Inc., Yahoo! Inc., Xerox Corp., Eastman Kodak and more.

Despite all the talk of job creation, there are still companies, such as Yahoo!, Abbott Laboratories, Barclays PLC, Lowe’s Companies, the Boeing Co. and the Walt Disney Co. to name more than a few, that recently announced fresh layoffs.

Drilling down closer on Starbucks’ revised outlook, we find the impact of rising commodity prices is starting to be felt. The company now expects earnings of $1.43 to $1.47 a share for fiscal 2011, with commodity costs to cut earnings by about 20 cents per share compared with a forecast of 8 cents to 10 cents a share in November.

Starbucks is not alone. McDonald’s also shared on its earnings conference call that while it has locked in as many costs as possible, it faces higher food costs in the coming year and the company will raise prices on some menu items in the coming months to offset those higher costs.

Per an updated forecast from the U.S. Department of Agriculture’s Economic Research Service, food prices overall are going to increase 2 percent to 3 percent this year at both grocery stores and restaurants. By comparison, the agency’s all-food index showed a mere 0.8 percent increase between 2009 and 2010, and a rise of just 0.3 percent for food-at-home prices.

Right about now, you’re probably wondering where I’m going with all of this. Well, when I look at all the data it would appear that an economic rebound is under way; however, the combination of high unemployment with rising input costs will hamper the speed of the recovery. Adding jobs will help. However, companies will need to balance hiring with the ability to pass costs through to customers, be they consumers or companies. With that said, I am not surprised the Federal Reserve shared a lukewarm perspective on the economy this week. Nor am I surprised it cited the unemployment rate to justify its $600 billion buying program of U.S. government debt.

The question to wrestle with is, what will happen to the stock market when the Fed completes its current bond-buying program at a time when we are feeling the fuller effects of recent commodity price and other input costs? Sounds to me like the interest rates are likely to tighten faster than the job market, which could weigh on the economic recovery and the market. Historically, the stock market has reacted negatively to rising interest rates, which increase the cost of borrowing and have an impact on corporate bottom lines.

Chris Versace, the thematic investor, is the director of research at Think 20/20, an independent equity-research and corporate access firm in the Washington, D.C., area. He can be reached at cversace@washingtontimes.com. At the time of publication, Mr. Versace had no positions in companies mentioned. However positions can change.