Short-Term Gains. Long-Term Pains? (Broker Talk)

Published Oct. 16, 2009 at 4:00 a.m.

The declining value of the U.S. dollar, along with significant government intervention, will continue to bolster the economy in the short term, but the markets, and the economy, will become riskier when the world's central banks pull back.

Who's Talking: David Joy, Chief Market Strategist, RiverSource Investments for Ameriprise Financial

The Gist: Investors will likely expect more growth from companies after the third quarter. In the meantime, a weak U.S. dollar will give certain sectors a boost.

Investors are wondering how third-quarter earnings, which are starting to be reported, will compare to the second quarter, when earnings generally exceeded expectations. Businesses that outperformed in the second quarter generally boosted profits through cost cutting, says Joy, rather than boosting sales. Of the 10 stock market sectors, only financials actually increased revenues, he says. The question now is whether investors will actually tolerate little to no revenue growth again even if a company still beats profit expectations. So far, says Joy, both revenue gainers and cost containers are being rewarded. Cost cutting "as a means to a better bottom line is still sufficient for now," he says.

And some companies will enjoy better earnings this season for another reason: the decline of the U.S. dollar. The value of the dollar dropped by more than 4% in the third quarter and more than 10% in the past six months. That is especially good news for companies that earn the bulk of their revenue abroad, such as tech, energy, materials and industrial companies, says Joy. Alcoa (AA) last week reported firming prices and growing demand overseas, for example, and materials companies should generally follow suit.

So far, earnings this season have been strong. Seventy-one percent of companies have beat earnings expectations in the third quarter, compared to 74% in the second quarter. But the market won't enjoy the luxury of investors' low expectations for much longer, says Joy...By the fourth quarter, "the bar may be raised," and companies will need to rely on more than a weak dollar and low expectations to outperform.

---

Who's Talking: The Wells Fargo Economics Group

The Gist: The market is being heavily influenced by the actions of central banks, but easy credit won't last forever.

The Federal Reserve's and the Bank of England's recent purchases of Treasury bonds, corporate bonds and asset-backed securities have made credit cheaper and easier than it would be otherwise, says the group. If the private market were "left to itself," the cost of consumer credit would likely go up, and its availability would go down.

But since economic policies are influenced by politics, government involvement in the market might go on longer than it should. After all, the group says, voters (and their interest groups) want consumer access to housing and cars, and so they use the political process to promote government influence in the credit markets longer than is needed. For this reason, says the group, government support for easy credit during this recovery will be "sustained" and "significant."

Once governments withdraw from interventionist policies, however, interest rates will rise, growth will slow, and the market will find a new equilibrium. Last week's interest rate hike by the Australian government left some investors wondering if other major central banks would also consider raising rates soon. But that's not likely, the group says. Other advanced economies are "significantly weaker" than Australia's. The Fed and the European Central Bank (ECB) will keep interest rates on hold "well into next year," the group says. However, Australia's rate increase did influence the U.S. market in another way, by pushing up the value of the Aussie dollar and driving the U.S. dollar down.

SMARTMONEY ® Layout and look and feel of SmartMoney.com are trademarks of SmartMoney, a joint venture between Dow Jones & Company, Inc. and Hearst SM Partnership. © 1995 - 2009 SmartMoney. All Rights Reserved.

Back | Read more at Smart Money