Are Earnings Signaling an Economic Bottom?

The market clocked a third straight week of gains last week, though measly by comparison to the prior two weeks, as companies continued to report better-than-expected earnings, and economic data signaled that the recession is easing. Last week capped the best month for the Dow since 1989, rising 8.4% for the month of July. For the week ended July 31:

  • Dow: Up 0.86% to 9,171.61
  • S&P 500: Up 0.84% to 987.48
  • Nasdaq: Up 0.64% to 1978.50

While second-quarter earnings were in focus last week, economic data was also a main driver. We saw signs of stabilization in the housing sector as new-home sales shot up 11% in June, marking the third straight monthly increase. Also, home prices in major U.S. cities increased sequentially in May for the first time in almost three years, according to the S&P Case-Shiller home price index.

Although prices and sales remain down from year-ago levels, the signs of stabilization are important for recovery prospects. Speaking of which, the economy contracted by a mild 1% in the second quarter, signaling that the recession is easing. This compares with steep declines of 6.4% and 5.4% in the first and fourth quarters, respectively.

Earnings reports serve as tea leaves for economy
As earnings reports continued to flow in, many companies said they are seeing signs of stabilization if not a bottoming in the economy. However, most companies have yet to post revenue growth, leaning on cost cutting (i.e. laying off workers) to boost bottom lines

Both Visa (NYSE: V  ) and MasterCard (NYSE: MA  ) posted better-than-expected second-quarter earnings, though mostly through cost cutting. However, charging higher fees to banks also helped MasterCard. Both have been sheltered from the credit markets because they make their money off transaction fees, not lending. However, both are feeling the brunt of lower consumer spending. MasterCard said weakness in consumer spending globally would make it tougher to meet its targeted average annual revenue growth.

In a sign that the steel market has bottomed, U.S. Steel called back 800 workers and has plans to restart an idle plant in Minnesota next month. The steel producer clocked a second-quarter loss and expects an operating loss in the third quarter on lower operating rates and prices. The company said prices are stabilizing in the U.S. and Europe, and says it thinks shipments and rates will increase in the third quarter.

Dow Chemical (NYSE: DOW  ) swung to a loss in the second quarter on costs associated with its acquisition of Rohm and Haas but said it saw demand picking up for chemicals and plastic products -- good news as those materials are the base for most consumer products. The company also said its customers were no longer cutting inventories and that the U.S. economy has bottomed, but that recovery will be slow.

Verizon (NYSE: VZ  ) reported a 21% decline in second-quarter earnings and said it would slash 8,000 jobs, as the company reels from a decline in business spending. The company says it doesn't expect improvement in business spending anytime soon, as it's fueled by employment.

The king of energy, ExxonMobil (NYSE: XOM  ) , is feeling the brunt of the recession as weakened demand for fuel and lower natural gas and oil prices drove second-quarter profits a whopping 66% lower. Revenues tumbled 46%.

Tech titans Microsoft (Nasdaq: MSFT  ) and Yahoo! (Nasdaq: YHOO  ) finally struck an Internet search partnership that could give Google a run for its money by increasing Microsoft's share of the online search market. Microsoft might have gotten the better end of the bargain, as investors sent shares of Yahoo! down on the news. In the 10-year deal, Yahoo! receives no cash upfront and gets only 88% of search engine revenues, compared with 100% before.

What's ahead
Second-quarter earnings continue to roll out, though lighter than the past two weeks, with companies from Pulte Homes to Kraft Foods to Toyota reporting.

Investors will continue to look for hints the recession is easing. Let's see if less bad data, which has been considered good in the market's view, will keep the market's positive momentum going.

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Fool contributor Jennifer Schonberger owns shares of Microsoft, but does not own shares of any of the other companies mentioned in this article. Google is a Motley Fool Rule Breakers pick and Microsoft is a Motley Fool Inside Value recommendation. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


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