Fidelity: What’s Really Holding Stock Prices Back (It Isn’t the Fiscal Cliff)

A somewhat knee-jerk explanation for the stock market’s fall swoon has been the instability surrounding the outcome of the presidential election and the higher tax revenue and spending cuts that will kick in January 1st if the fiscal cliff negotiations stall out.

So now that we’ve resolved the presidential election piece of the puzzle and the smoke signals out of Washington suggest some sort of cliff resolution will be reached before year-end, we’ve removed the big clouds hanging over the market. Right?

Not so fast, suggests Jurrien Timmer, co-manager of Fidelity Global Strategies Fund. “I am not sure that as soon as our leaders in Washington come to a deal on the fiscal cliff and taxes, the stock market will rocket higher, at least not for long,” surmised Timmer in a recent note Fidelity prominently plastered on its website as a none-too-subtle warning.

Timmer is concerned that If the resolution of the fiscal cliff tilts too far into the realm of austerity, that’s not going to be a pretty picture in terms of consumer demand and business expansion. He suggests Greece as a guidepost for how well that’s worked out. Timmer also makes a case that the latest round of the Federal Reserve’s Quantitative Easing has had a diminished impact on the market compared to Rounds 1 and 2. That’s a signal that Bernanke and crew have spent their bullets. (In a radio interview earlier this week with American Public Media’s MarketPlace, Warren Buffett made exactly the same point.)

Timmer’s conclusion: “If the growth in fiscal stimulus has peaked and monetary stimulus is losing its effectiveness, stock prices will have to go up the old-fashioned way, through the fundamentals of higher earnings growth.”

And that’s not looking too promising. According to FactSet, of the 486 companies in the S&P 500 index that have reported third-quarter results, the average earnings growth rate is -0.9%. If the final tally stays in negative territory it will be the first down stretch in 11 quarters.

What’s got market watchers especially concerned is that while most of the S&P 500 companies managed to beat their (lowered) earnings expectations, only 41% managed to beat on revenue. That’s just about as disappointing as the 36% that had better-than-expected revenue growth in the second quarter. The typical average beat is 55%.

Of the five largest components in the S&P 500 index, only Apple (AAPL) has managed strong relative revenue growth, though it’s still a slow down for the sales juggernaut.

AAPL Revenue Quarterly YoY Growth Chart

AAPL Revenue Quarterly YoY Growth data by YCharts

Stephen Biggar, S&P Capital IQ’s Managing Director of Global Equity Research isn’t expecting a sudden turnaround. In his firm’s 2013 Investment Outlook he said: “A weak Q3 earnings reporting season was highlighted by many examples of reduced forward earnings guidance as expense efficiency efforts were less able than in prior years to offset weak revenue growth. This trend is likely to continue, in my opinion.”

There’s just not enough demand. Consumer spending isn’t coming to the economy’s rescue.

US Consumer Spending Chart

US Consumer Spending data by YCharts

Nor is manufacturing.

Philly Fed Manufacturing Future Activity Index Chart

Philly Fed Manufacturing Future Activity Index data by YCharts

And that’s why Fidelity’s Timmer thinks any rally will be short-term based on relief that Washington didn’t screw things up. Beyond that there’s not a lot to suggest corporations have the demand to drive significant revenue growth that can give a big jolt to earnings.

“Certainly the housing market is a bright spot in the economy, and perhaps Europe and China will muddle along without too many air pockets. But right now I don’t see the ingredients for a sustained rally in equities,” wrote Timmer.

Carla Fried, a contributing editor at, has covered investing for more than 25 years. Her work appears in The New York Times, and Money Magazine.


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