The Big Picture

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• Late Afternoon Reads
• First Day IPO Pops
• Big IPO Runups of 1975-2006
• Do You Understand Earnings Estimates?
• Existing Home Sales Falter
• Individual investors get nervous
• Understandings Earnings Estimates
• Morning Reads
• Economic data
• The “Vacuum” of Financial Leadership

Late Afternoon Reads Posted: 19 May 2011 01:30 PM PDT This is what I will be reading on the way home tonight: • When Regulators Side With the Industries They Regulate (NYT) • Is Facebook the Next MySpace? For Media Sales, Maybe (GigaOm) • Has the US passed peak productivity growth? (What Matters) • What Does LinkedIn IPO Mean for the Economy? (Real Time Economics) • Tim Harford on Unexpected Economics (The Browser) • James Altucher: About Me In 15 Questions (Stock Twits) • Ins and Outs of Using Gadgetry (NYT); 25 More Tech Tips and Tricks (NYT) • Judgment Day? Five failed end-of-the-world predictions (CSM) • 100 Best Albums of the Nineties (not really) (Rolling Stone) What are you reading?

First Day IPO Pops Posted: 19 May 2011 12:05 PM PDT In light of today’s LinkedIn (LNKD) double, I want to refer you to this spectacular act of research by Prof. Jay R. Ritter of the University of Florida, who reviewed the initial public offerings (IPOs) of common stock ( >$5.00 and proceeds >$5 million) of all non-ADR operating companies during 1975-2004 that at least doubled in price on the first day of trading. The ten biggest first-day percentage increases are: 1. Va Linux (12/09/99)  697.50% 2. Globe.com (11/13/98) 606% 3. Foundry Networks (9/28/99) 525% 4. Webmethods (2/11/00) 507.50% 5. Free Markets (12/10/99) 483.33% 6. Cobalt Networks (11/05/99) 482% 7. MarketWatch.com (1/15/99) 474%, 8. Akamai Technologies (10/29/99) 458% 9. Cacheflow (11/19/99) 426.56% 10. Sycamore Networks (10/22/99) 386%. Professor Ritter’s full research piece has 100s of IPO first day price pops, and makes for fascinating reading. > click for full research piece

Big IPO Runups of 1975-2006 Posted: 19 May 2011 11:27 AM PDT Big IPO Runups of 1975-2006 ~~~ This has been prepared by Prof. Jay R. Ritter of the University of Florida using data from CNNfn, Yahoo!, Securities Data Co., and Bloomberg

Do You Understand Earnings Estimates? Posted: 19 May 2011 10:15 AM PDT > Run-don’t-walk to see Jim Bianco’s fascinating discussion on Understandings Earnings Estimates. >

Existing Home Sales Falter Posted: 19 May 2011 09:00 AM PDT click for ginormous graph chart courtesy of Calculated Risk > In April 2011, Existing-home sales fell 0.8% to a seasonally adjusted annual rate of 5.05 million in April from a downwardly revised 5.09 million in March This represents a 12.9% from April 2010, a tax credit driven sales period. All-cash transactions were a still high 31% in April, down from the record 35% in March. > Previously: 20 Startling Facts About the US Housing Market (May 19, 2011) Source: April Existing-Home Sales Ease Realtor.org, May 19, 2011 http://www.realtor.org/press_room/news_releases/2011/05/sales_ease

Individual investors get nervous Posted: 19 May 2011 08:04 AM PDT From the perspective of the always fickle individual investor, the sharp commodity pullback which modestly shook the tree in stocks over the past few weeks has gotten them more cautious. The AAII measure of individual investor sentiment (as opposed to the II measure of newsletter writers which still shows a small amount of bears and elevated bulls) saw Bulls fall to 26.7 from 30.8, the lowest since Sept and the Bears rise to 41.3 v 35.5, the most since Sept. It certainly was a good contrarian set up for yesterday’s rally but I’m still of the belief that a downward trend with lower highs has begun. In Asia, with just 3 weeks left before Q1 ended, the Japanese disaster basically froze their economy as the full Q saw a contraction of 3.7% annualized, almost twice the expectations of -1.9%. In Europe, Spanish bond yields continue to creep higher after Spain sold 10 and 30 yr paper that in total were 800m euros less than expected and the bid to cover for both were below 2.0. Positively for the US consumer, gasoline prices fell another .02 and are now down .08 over the past week to a still painful $3.91 for many.

Understandings Earnings Estimates Posted: 19 May 2011 08:00 AM PDT In the video above, Hewitt Packard's CEO Leo Apotheker said the following: Carl:  Before we let you go, Leo, I don't know if there's been a quarter since you joined where the company beat, if you will, I wonder you've got to be looking forward to that day. Leo Apotheker: We've beat this quarter. Carl:  But with accompanied by guidance that was very disappointing.  Every quarter has had some level of disappointment. Are you looking forward to one where there is none? Leo: Of course. But I just want to make sure we get the facts right. We beat expectations in Q2 both on a revenue and margin side and EPS side. Let's get the facts straight. Becky: But the stock market is showing your stock down 5% this morning because of disappointment about the outlook for the third and fourth quarters. That's a concern. Apotheker:  I can easily understand that. We will walk our investors through our guidance for the rest of the year and explain the reasons. But I would like to make sure that we get the verbiage right and the facts right. You did beat for this quarter you beat both on the bottom and top line. That's good news. The transcript cannot convey the frustration in Apotheker's voice when he was accused of missing expectations for the current quarter.  He can understand the stock falling, he can understand the outlook being poor, but do not accuse him of missing on the quarter.  Apotheker stressed this point multiple times. Gamed Earnings As the next two charts show, beating earnings and revenues expectations is nothing new.  Aggregate S&P 500 earnings have beaten expectations for 50 straight quarters, including the current quarter.  As we explained last July: The chart below highlights the inception of SEC regulation "FD" (aka, Fair Disclosure). Before FD roughly 50% of companies beat expectations, as would be the case if analysts were trying to get it right. Now that companies have to disclose to all at the same time, we believe their investor relations departments are masters at "guiding" analysts just below actual earnings. This way the companies "beat" expectations and get the positive press and accolades that come with it. Further, it seems that everyone is happy with this apparent gaming of the system. This is why we believe the percentage of companies that beat expectations is a meaningless statistic. The game is designed for this to happen, even when earnings are collapsing (during 2008′s epic collapse in earnings more than 50% of companies still beat expectations). Note that the percentage of companies beating estimates has been falling in recent quarters, from 75%  in the first quarter of 2010 to 67% in the first quarter of 2011.  By this metric, earnings are not doing that well. Click on chart for a larger image In recent quarters investors have caught on that earnings are gamed and have greatly discounted these results. So they are now turning their attention to revenues. The next chart shows the percentage of S&P 500 companies that beat revenues estimates. This data series only started in 2006. Click on chart for a larger image At first blush revenues appear to offer a more honest view of companies' financial outlooks than earnings. If analysts were actually trying to get it right, the number of companies beating the benchmark should vacillate around 50%. Revenues estimates did exactly this. In recent quarters, however, revenues are showing an upside bias. Is this because companies are genuinely reporting good numbers or are the investor relations departments now gaming these numbers as well? It's hard to tell. But we can say in our unscientific review of earnings releases that companies are highlighting revenue beats more now than ever. This is a red flag that these numbers are also being gamed. Earnings Estimates In the next video Robert Keiser, vice-president of S&P's valuation and risk management strategies team, applauds the earnings numbers and suggests they are the most important driver of higher stock prices. Melissa:  Does it simply tell us that Wall Street got it wrong when it came to the first quarter, that the expectations were too low? Robert Keiser:  There were double digit earnings growth where the S&P outperformed expectations and the economy is growing 2 to 3% and consistently. In terms of the second floor, based on the company's guidance, they give guidance and beyond, obviously we have a much better sense in terms of the reaction themselves. The analysts said estimates for S&P earnings are now up to $99.90 and the bar has been raised. Later Keiser said: Keiser:  The S&P estimate is right now going to earn $112 a share. Every quarter that the market either meets or beats expectations, there's a little bit more confidence and it's going to take about 1400 and sometime in 2012. Keiser's assumption is that earnings estimates are stable and even somewhat accurate.  However, as the next two charts show, the 12-month forward earnings estimates as calculated by Bloomberg are $122.44 for the S&P 500, essentially the same as S&P's estimates.  However, the second chart shows, the error rate between forward earnings estimates and actual earnings is growing.  The worst miss occurred in 2008, which exceeded the record set in 2001. In other words, earnings estimates are becoming less accurate, not more accurate. So before Keiser tells us that the forward P/E ratio on an estimate of $112 is cheap, why should we believe this will happen?  Forward estimates were also that high in 2009.  How did that work out? Click on chart for a larger image Click on chart for a larger image Conclusion Current quarter earnings estimates are gamed and 12-month forward earnings estimates are getting worse over time.  Use them in valuation estimates of the market at your peril.

Morning Reads Posted: 19 May 2011 07:30 AM PDT Some interesting reads to go with your second cup of coffee: • LinkedIn (LNKD) is the Most Expensive Stock in America (Smart Money) and that was before it opened +90%! • Earthquake and Aftermath Push Japan Into a Recession (NYT) • Eric Schneiderman: One Lawman With the Guts to Go After Banksters (Nation) • The Hot-Money Cowboys of Baghdad (NYT Magazine) • Citigroup's Hedge-Fund Returns Jump as Volcker Rule Looms (Bloomberg) • Collateral Damage: the True Cost of a U.S. Default (Barron’s) • The Case for Bringing Back BABs (Treasury) • Welfare-queen states (Washington Post) • What Not to Say in a Job Interview (Fins Finance) • 30 Under 30: New York’s Hottest Up-and-Comers (Zagat) What are you reading?

Economic data Posted: 19 May 2011 06:42 AM PDT April Existing Home Sales totaled 5.05mm annualized, 150k below forecasts and down from 5.09mm in March. Sales for both single family and condos/co-ops were down and because the absolute number of homes for sale rose by 350k to the most since Sept, the months supply rose to 9.2 from 8.3, the most since Nov. The median home price fell 5% y/o/y. Distressed sales made up 37% of sales vs 40% in March. Bouncing along the bottom remains the theme and highlighting the influence of tight lending standards and stricter appraisal readings, the NAR said 15-20% of home sales are being held back “due to the very restrictive loan underwriting standards” and 11% of contracts were cancelled because an appraisal was below the negotiated price, 10% had a contract delayed and 14% said a contract price was “renegotiated to a lower sales price as a result of a low appraisal.” Also unsaid by the NAR, more want to rent than own right now. Following a weak NY mfr’g survey on Monday, the May Philly mfr’g survey was well below expectations at 3.9 vs the estimate of 20.0 and down from 18.5 in April. It’s the lowest since Oct. New Orders fell to 5.4 from 18.8 and Backlogs went negative to -7.8 from +12.9. The bright spot was the Employment component which rose 10 pts to 22.1, the 2nd best since ’04 (but the 6 month outlook in hiring fell 15 pts). The Avg Workweek fell to 3.9 from 17.7. Prices Paid fell to 48.3 from 57.1 and Prices Received was down by 10 pts, both a quick response to the commodity relief over the past few weeks. Also disappointing to the headline Philly figure was the 6 month outlook which fell 17 pts to 16.6, the weakest since Jan ’09. Bottom line, we need to see more regional surveys and the national ISM to get a full view of the state of mfr’g nationally but data seen so far this week shows there is a clear moderation after heady gains.

The “Vacuum” of Financial Leadership Posted: 19 May 2011 04:45 AM PDT Pulitzer prize winning investigative reporter Jesse Eisinger — he insists I write that intro every time I mention his name (heh heh) — has an interesting ProPublica/NYT column out this morning looking at the many empty appointments at key agencies in Washington DC: “The administration has inexplicably left open the vice chairman for banking supervision, a new position at the Federal Reserve created by the Dodd-Frank Act, despite having a candidate that many people think is an obvious choice: Daniel K. Tarullo. The new Consumer Financial Products Board chairman is unnamed. There are some lower-level positions that don’t have candidates, including the head of the Treasury’s Office of Financial Research and the Financial Stability Oversight Council insurance post. Perhaps most important, the Office of the Comptroller of the Currency, is being headed by an acting comptroller, John Walsh, who took over the agency last August. Nine months have passed without a leader who might better reflect the Obama administration’s views on banking regulation, a time lag made worse by the office’s coddling of the banks even as they have acknowledged rampant abuse and negligence in the foreclosure process.” You have to love this paragraph: “Even low-level appointments are now deeply partisan affairs, the playthings of score-settling senators with memories like elephants and the social responsibility of hyenas (which probably insults hyenas).” My solution? Go a little Seal Team 6 on the Senate minority GOP leadership. Tell them to sit down with the President’s list and hammer out a compromise. The alternative to obstructionism is to pull a page out of George W. Bush playbook and after 2 years of foot dragging, fill the full slate via recess appointments — including Elizabeth Warren as FCIC Chair. Its time for the kiddies in DC to grow up and behave like adults. > Source: At a Time of Needed Financial Overhaul, a Leadership Vacuum Jesse Eisinger ProPublica, May 18, 2011 http://www.propublica.org/thetrade/item/at-a-time-of-needed-financial-overhaul-a-leadership-vacuum/

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