Markets to Sell Off at Open on Disappointing Earnings From Wachovia et. al.

July 22, 2008 – The markets are set to sell off at the open this morning as the Street reacts to earnings reports from Wachovia (NYSE:WB), American Express (NYSE:AXP) , Apple (Nasdaq:AAPL) and Texas Instruments (NYSE:TXI) disappoint.  Traders are also reacting to comments this morning from Treasury Secretary Paulson, who is urging Congress to approve a support package for Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE). Later today, the Congressional Budget Office is scheduled to provide an estimate of the budgetary impact of the administration’s request for support for Fannie and Freddie.

To be sure, the impact on the national debt will be to add to it, and so the impact on the dollar will be to further weaken it. The implications here will be more pressure on a weakening dollar and an exacerbation of inflationary pressure to the consumer. Meanwhile, the Street is coming to grips, based on the earnings reports from several leaders this morning that consumers are pairing back their spending, which shouldn’t come as a surprise. We have argued for the past year that consumers are tapped out. With negative personal savings, record credit debt, a softening dollar with increasingly less buying power, growing uncertainty in the labor market and a confluence of other negative economic headwinds, consumers, which represent more than 70% of GDP, are in pretty bad shape.

On the corporate front,

·         Wachovia announced an $8.86 billion loss in Q2, or $4.20 per share, as opposed to earnings of $2.34 billion, or $1.22 per share last year. Excluding $6.1 billion in write-downs and restructuring charges, it lost $2.67 billion, or $1.27 per share. Expectations were for a loss of $0.78 per share on revenue of about $8.4 billion. Wachovia also announced that it is cutting its dividend and 6,350 jobs.

·         UPS (NYSE:UPS) reported that profit fell 21% in Q2 to $873 million, or $0.85 per share, on revenue of $13 million, up from $12.2 million.

·         Caterpillar’s Q2 profit increased 34% to $11 billion, or $1.74 per share, compared with $823 million, or $1.24 per share on revenue of $13.62 billion (which also rose, by about 20%). Analyst expectations were for earnings of $1.54 per share.

·         Lockheed Martin (NYSE:LMT) reported Q2 earnings of $882 million, or $2.15 per share, up 13% Y/Y on revenue of $11 billion. Expectations were for earnings of $1.88 per share on $10.86 billion in revenue. ·         Ultralife Batteries (Nasdaq:ULBI) announced an $11 million military battery order from the U.S. Defense Department.

Wit, Wisdom, Fools and Folly

·         When is Treasury Secretary going to stop telling us that the economy is fundamentally strong? Who believes this?

·         Charles Plosser has been pounding the table this morning that the current low interest rates are going to create more inflationary pressure and that the Fed needs to raise rates. We agree. The fact that the economy is recessing can’t be changed by the low rate structure. But consumers sure could use some help from the Fed supporting the purchasing power of their dollars.

In terms of what we expect in today’s session, more downward pressure. The Treasury Secretary keeps beating the drum that he needs Congress to approve on all of his recommendations to “instill confidence in the financial system” but we would counter that request by asking why we should have confidence in the financial system and why should we have confidence in the administration’s ability to make the recommendations to bring it about? Clearly the administration and its turn from a strong dollar policy in the last seven years, which has exacerbated the dollar’s weakness and the inflationary pressure we are seeing today hasn’t been a good move. And clearly the policy decision and tone set at the top in Washington that debt is an acceptable long-term instrument to drive the economy has unraveled in the financial and mortgage industries, not to mention that consumers are reeling now from record credit debt.

We don’t have confidence in Paulson, and we don’t have confidence in the economy, and getting Congress to approve a blank check to bail out Fannie and Freddie doesn’t instill too much confidence either. This is all of the backdrop against which we have to cope with the markets, and it just amounts to too much pressure on stocks at this point. So we remain bearish in the near term and think a retracement of the recent lows is likely.

There are a few bright spots out there, and in particular, we would point to the alternative energy and clean tech sectors that are demanding billions in investment from the private sector and Capitol Hill. The secular trends that will drive growth in adoption of alternative energies are well in place and we see them continuing for the foreseeable future.

We urge our readers to remain defensive, but opportunistic and to remain disciplined in picking entry points into long-stock positions. Don’t buy into the notion that ‘stocks are oversold’ or ‘cheap on an historical basis.’ The bottom line is that every day facts change in the economy we are compelled to recalibrate what ‘fair value’ really is, relative to this fluid state of the economy. And the fact is that we have never seen so many negative events happening at once.