October 23, 2009 Edition, Volume III

Inside Signature Update

• The Market – Top Line Sales Growth Wanted
• The Economy – Demand Driven Oil
• The Takeaway – There’s Room for Growth and Profits

THE MARKET – Top Line Sales Growth Wanted

Earnings reports continue to support the domestic equities rally with the DOW holding near the 10,000 level.   Most often investors and traders focus on earnings rather than the total revenue line as equity values are often discussed as a function of earnings per share (EPS) or the price to earnings ratio (PE).   In recessive times skilled business managers reduce expenses to make up for lagging revenues in an effort to 1) survive and 2) provide profitability for shareholders.  Market analysts adjust their expectations accordingly, confident that margins as secure as possible.

As the post-recession market trends higher, the focus shifts to revenue growth – or top line sales figures.  Sales growth represents overall market improvement and becomes the catalyst for higher profits and stock valuations.  Same-store sales growth for retail outlets and industry revenue gains for technology, manufacturing, and banking are key in this part of an economic cycle.

Thus far, the figures have been encouraging enough to hold markets at impressive levels while market makers and others pour over incoming reports, but the real test will be in consumer sales as we head into the critical Christmas retail season.  Management and analyst’s expectation are optimistic for year-over-year improvement, but following 2008’s disappointing results that’s not saying much.  The important retailers to watch are mid-range and high-end chains such as Target, Kohl’s and Nordstrom.  Wal-Mart and Costco have already benefited as consumers shifts away from higher-end retailers in search of bargains during the recession increased revenues.  The test now becomes whether or not more expensive retailers can bring shoppers back without discounters losing market share.

Gains in manufacturing and distribution appear to be following suit as low inventory levels requiring replenishment and mild consumer spending increases add fuel to recovery trends.  Expectations for an 11,000 – 12,000 point DOW still seem optimistic, but not as wildly so as in the latter part of the summer.

THE ECONOMY – Demand Driven Oil

We often speak the price of gold in terms of the value of the dollar, suggesting that it rises and falls as a byproduct of international exchange rates more than any other factor.  And while industrial demand for gold and other precious metals does have an impact, it’s decidedly less significant.  That’s not true for all commodities; including oil.

The price of a barrel of oil is once again on the rise, and only part of the increase can be accounted for relative to the value of the dollar.  As the economy improves, both domestic and international, the demand for oil as an energy resource rises in direct proportion.  One would think that a 2-3% increase in demand for any material would produce a similar increase in price, but not so.  Demand increases, or decreases, disproportionately alter pricing when production has limits, either real or imposed; as is the case with oil.  When consumer demand for gasoline decreased by 8% at the end of summer 2008, oil prices began to spiral downwards and finally rested near $35 per barrel.  It appears the decline from $147 to below $60 was due to real demand destruction in the market, while the remaining decline may have been a result of fear over a declining US economic market and a crumbling of the speculator and hedge fund market.  The resultant devaluation of the dollar against other currencies actually helped oil pricing to stabilize and rebound to the $50-$70 price level.

We’re now on the other side of the demand scenario.  Oil has now topped $81 and with the improvement of the economy, energy demand is on the rise.  At the same time, the dollar continues to weaken and oil, like gold, may once again become subject to speculative forces.  Though we can point to a ‘greener’, more energy efficient domestic market, we certainly haven’t made the improvements needed to curb the US demand for refine-able crude.  Watch for oil to breach $100 per barrel before the end of Winter 2010 – it will come as a good news, bad news scenario as it tells of continued improvement towards economic recovery and a further slide in the value of the dollar.

THE TAKEAWAY – There’s Room for Growth and Profits

• Expect more encouraging news from the earnings front as some of the nation’s largest corporations report next week, but short-term pressure could dampen the market if the Case-Shiller Index (real estate index due out next week) disappoints.

• The US stock market has room for further gains, especially as we move beyond October’s historically treacherous reputation. 

• Though international equities also offer meaningful performance gains, continued dollar weakness threatens to offset investor benefit. 

• Oil producers and refiners may offer short to mid-range gains, but gold continues to be sufficiently high to be in full speculation mode. 

[1] Signature Update is offered by [2] Richard Haskell, Managing Director of [3] Signature Wealth Management  and CEO of [4] Signature Management, LLC