November 16, 2012 at 10:31 AM EST
After a Terrible Q3 Earnings Season, Big Companies Have to Deal with This

Q3 Earnings SeasonIf we had any hopes about the corporate earnings of big-cap companies improving, those hopes are close to being thrown out the window now. The most basic calculation of profit includes two factors: sales and costs. If costs increase, then corporate earnings suffer. If sales decrease, corporate earnings suffer again.

At this point, we know that third-quarter corporate earnings at big-cap companies were hit by softened revenues due to slowing demand from their customers and the uncertainty of the global economy.

Now big companies face another issue that could take their corporate earnings even lower.

Import prices in the U.S. economy have been increasing for three consecutive months. In October, there was an increase of 0.5%. September and August witnessed an increase of 1.1% and 1.2%, respectively. (Source: Bureau of Labor Statistics, November 9, 2012.) The average import-price increase per month since 1990 has been 0.2%. August, September and October 2012 all showed that import prices increased by much more than the average.

These price increases mean that corporate earnings of big-cap companies that rely on imports are going to suffer. Third-quarter profits were blamed on slowing demand, but I believe fourth-quarter corporate earnings will also be pressured due to rising prices.

The main culprit for all these increases is the falling U.S. dollar, as it significantly affects commodities prices. But I’m not going to discuss that much. All I have to say is: look at the chart below of the U.S. Dollar Index. The Index has sunk more than three percent from the beginning of August to now. In the same period, import prices have increased 2.8%.

usd stock market chart

 Chart courtesy of www.StockCharts.com

Big-cap companies go around the world to shop for their supplies to make goods…to bring down their costs and increase their corporate earnings. With the falling U.S. dollar, their buying power is lower.

Previously, big-cap companies were able to force these price increases onto their costumers, but that will also cause the prices of goods to rise. To defend their pockets, big-cap companies will buy less or move toward substitutes, as slowing sales and increasing costs will put pressure on corporate earnings.

Keeping all this in mind, the falling corporate earnings of big-cap companies will cause the stock markets to go lower. It’s that simple. I don’t see any real recovery in the economy anytime soon, and the prevailing economic condition could last for a long time. Instead of economic growth, inflation caused by rising prices is more likely.

Michael’s Personal Notes:

I was recently talking to a friend of mine who considers himself a gold bear, somewhat of a rarity amongst my contemporaries. He believes gold prices are in a bubble and they will come crashing down, causing a lot of people to lose their wealth. He also added: “It’s just a metal, and no one can really use it.”

You know my take on gold; I think exactly the opposite. Gold has a history of being money—it has been a store of value and a unit of transfer for longer than the fiat currency created by central banks. Sadly, my friend listens to the mainstream gurus who only speak one side of the story.

Since the financial collapse in 2008, gold has become the only savior. Sure, the stock market has increased since 2009, but ask those people who bought in before the market collapsed and never sold about the stock market. I am sure they will disagree with the claim. The Dow Jones Industrial Average and other key indices are still trading below where they were before the financial collapse started.

Yes, gold is gaining a lot of attention, but it is nowhere close to being considered as being in bubble status. A commodity, stock, or anything is usually in a bubble when the vast majority of people you speak to are in the game. Think about the tech bubble of the late 1990s or the real estate bubble of 2005–2006. Right now, few people are talking about gold as an investment; and if they are, I hear more people talking about being against gold than about buying it.

To me, gold still provides safety against uncertainty. For example, gold prices jumped in price when the Pentagon announced that Iran tried to shoot down a U.S. unarmed and unnamed surveillance drone on November 1.

Similarly, there is growing demand for the yellow metal. According to Thomson Reuters GFMS, China’s demand for gold will exceed the demand for gold by India for the first time. The Chinese demand for gold will reach 869 tonnes in 2012, and it will be in both jewelry and investment. (Source: Reuters, November 8, 2012.)

In addition to all that, central banks are continuously printing their respective currencies. From 2008 to 2011 alone, the Federal Reserve has printed $2.3 trillion. Other central banks are doing the same. The Bank of Japan increased its asset purchase program. The European Central Bank (ECB) has decided it will continue to buy an unlimited amount of debt from suffering nations, and the Chinese central bank has been continuously taking measures to turn its slowing economy around. (Source: Bloomberg, November 9, 2012.)

So, my friend may continue to believe gold is in a bubble. And we’ll see who is eventually right, as markets always reward the person who is on the right side. For me, gold meets all the criteria to soar even higher. Uncertainty is still present, demand is increasing, and central banks are expected to continue printing fiat money.

Gold will shine, because there is only a limited amount of it. And, as I have been saying for some time now, dear reader, central banks cannot print more of it.

Where the Market Stands; Where It’s Headed:

I’m expecting 2013 to be a terrible year for the stock market. We saw stock prices rise in 2009, 2010, 2011, and, so far, marginally in 2012. I’m predicting that 2013 will be the turnaround year for the stock market, the year the bear market rally that started in 2009 fades into a fond memory.

What He Said:

“If the U.S. housing market continues to fall apart, like I predict it will, the stock prices of major American banks that lend money to consumers to buy homes will come under pressure—these are the bank stocks I wouldn’t own.” Michael Lombardi in Profit Confidential, May 2, 2007. From May 2007 to November 2008, the Dow Jones U.S. Bank Index of the world’s largest bank stocks was down 65%.

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