Saturday, October 20, 2007

Friday's market puzzles

The stunning stock market decline on Friday was, from this perspective, the result of two surprises, Caterpillar and Schlumberger. First, here are a few things that the decline was not about. It was not weak bank earnings. It was already clear weeks ago that big banks would post some bad numbers. With additional new accounting rules related to mark to market accounting in 2007, the Sarbanes-Oxley penalities for a miscue, and the fact that markets for many securities are not functioning well, the banks results were already in the cards. A few were worse than expected, a few not so bad, but overall this was not news. It was not Honeywell and 3M. They didn't help the tone of the market, but the misses were modest and related to explainable pressures. It was not Ben Bernanke's comments in which he more or less said that it's not easy to figure this stuff out, not exactly a leadership statement but not news. It was CAT and SLB.

Why? Both had results that had unexpected markers that on the surface were head scratchers. CAT has been in a sweet spot. It is a major global competitor in its business and the weak dollar has made its top quality products immensely competitive. Foreign currency revenues translate back into more and more dollars. Agricultural commodity prices are at or near record highs as global demand, spurred by additional upward pressure from energy related uses for corn, sugar, etc, has meant demand for its products. Infrastructure requirements in developing countries and even in the U.S. use its products. CAT is in great shape, and THEY MISSED AND THEY CUT THEIR EARNINGS OUTLOOK FOR THE YEAR! What? Their explanation was weakness in the U.S. related to a real estate construction slow down, and since everyone and their crazy uncle in the basement has known about the residential housing side of this for months the market drew the conclusion that it was COMMERCIAL CONSTRUCTION. That was chilling, but with all of the wind behind their backs at CAT, to think that this was dramatic enough to cut the 2007 forecast(last checked 2007 was 75% baked) was a shock, something that still needs more explanation, more clarity.

SLB beat the consensus earnings estimates by a huge margin but revenues were modestly less than expected, and they projected some pressure on revenues in the coming quarters. What? This is another company that has had everything going for it. Great products, market leading position, and an energy market that unquestionably has needs for greater development and exploration as the China's and India's soak up anything in their reach amidst global political uncertainties, continued G-7 growth, and varied supply issues. Prices are so good that any government in the world with offshore oil reserves to possibly be developed will spend bundles to try to tap into this resource. And SLB has pricing pressure. How? Why? From whom, since they have the greatest economies of scale in the oil service industry. This one is still a mystery. Does it presage some sort of global slowdown? Is there irrational competition that will lead to earnings misses across the industry? After two days of newspaper reports and pundits jabber it's not clear. Maybe Bernstein, or Bear, or JPM analysts will shed some light on Monday.

Those were, again from this perspective, unequivocally the two events that pushed an already volatile market over the edge on Friday. Depending on how they are clarified, they could either have been catalysts for a sort of healthy sell-off after a tenuous week in a market that had been ramping for a little too long OR they could be markers of two significant events that indicate a real downward turn in this market.

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