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October, 2018:

Q3 Earnings Are Coming In… Head for the Exits??

The new earnings season has started, and already several big names have revealed their earnings to the awaiting financial masses.   Microsoft, Google, McDonald’s have all weighed in.  More than half of the Dow Jones index has issued guidance for the 4th quarter, and none of it is looking good.  (edit: well, surprisingly Facebook turned in a positive surprise… good for them!)

So the question remains, should we be heading for the exits?

Personally, I think you can make a case either way.

When you buy a stock, you are buying a piece of a company’s earnings.  If you buy a share of Google, you are buying into the $32ish that the company made per share over the last 12 months, hoping that earnings per share will grow, or that Google will start to pay out a dividend.

But a share of Google costs a lot more than $32.  In fact it costs around $675 per share.  That difference is called the Price to Earnings (PE) multiplier.  At present, people wanting to invest in Google are willing to pay $21.20 for each dollar that Google earns.  Both parts of the equation carries equal weight.   Share price = Earnings per Share    X   PE 

And while the earnings per share of the overall market look to be anywhere from flat to a small decline overall, due to the Federal Reserve flooding the asset markets with easy money, the amount of money that an investor (or much more likely, an institution) is willing to pay for a dollar of those earnings is still destined to increase, because each month there are way more dollars having to compete for a share of any single asset.

Now does that result in overall stock prices going up or going down?  That’s the part that’s hard to say.  One side of the equation is pulling down, and the other is pulling up.    Whether the market increases or decreases depends on which pull is stronger.   But whatever the result, we are likely to see a lot of generally sideways action until earnings pick up again.

So how does make money when the market is going nowhere, or close to it?

Stay tuned, kids.

The Printing Press Race Is On

An interesting side effect of Quantitative Easing is that while the Federal Reserve is trying to stimulate spending and risk taking inside America, it has effects far outside of America.

Because when America suddenly finds that it has a lot more USD in circulation while other countries are still printing at the same rate, the value of the US dollar would tend to decline. We saw it through pretty much the entire Bush administration, as USGov was forced to issue debt at a much faster rate than other governments, causing the USD to lose roughly 40% of its value vs other currencies.

But here’s the issue for other countries. America is still the largest consumer of, well, pretty much anything. And when America’s currency goes down, everyone else’s currency goes up. Since a factory in China is paying its expenses in Yuan but collecting its profits in USD, it’s not in that factory’s best interest for its local currency to be gaining strength vs its profit currency. Simply put, when the USD goes down, everyone that exports to the US loses money.

Obviously, the central banks of these factories are aware of this plight. When factories lose profits, some of them close down, which increases unemployment. So what do you do when the world’s biggest economy has shifted the printing press into higher gear, and that threatens to make your currency so strong that you become uncompetitive?

The most obvious solution will most likely become the most popular. Exchange rates are all about ratios, (or at least perceptions of those ratios). So if the other guy has kicked the press into high gear, and you need to keep the same ratio… Expect China, Canada, Australia and pretty much everyone else to follow suit. (Europe was already printing up like crazy because of their own financial crisis.)

And because currency levels are now being actively managed by every central bank out there? We can probably expect to see a lot less volitility in exchange rates from now on.

“Hold on a minute,” I hear you asking “every major country in the world is going to start printing up currency even faster than before? That can’t possibly be good.”

Well, it certainly will have side effects. All that money has to go somewhere, all that money just sitting in a current account somewhere is not in a bank’s DNA. So it has to pile into an asset. Which means that despite corporate profits having gone flat, the amount of dollars competing for each dollar of corporate profits increase. And corporate debt. And pretty much any other big asset class. Inflation of assests, essentially.

However, that does not turn into inflation for the hot dog cart on the street.  Yet.

When we talk about inflation, we talk about the overall general level of inflation.  But that glosses over the reality that there is not just one level of inflation.  There are literally thousands.  The price of energy may go up over time, but the price of technology moves completely independently (and usually in the opposite direction).  The price of hot dogs moves independently as well.  And money spilling into junk bonds, for example, doesn’t effect the price of that hot dog on the street.

Until large amounts of people start spending more money on hot dogs (and other basic necessities) overall.   But if asset prices keep going up, people’s portfolios will increase right along with it.  And just like the housing boom, people will start treating their retirement portfolio’s like piggy banks, withdrawing (as opposed to borrowing against their house) whenever they get a whim for a faster car, a bigger TV, or hardwood floors.

At THAT point, all that money that’s being pushed into the system will result in big time inflation.  But that’s years down the road.  Maybe 10.  Maybe 20.  No one knows for sure.

Hopefully by that time, the brains at the Fed will have worked out a solution around that situation.

At this point, we can only hope.