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Perhaps you've heard this argument: Corporate cost cuts have swelled profits beyond analyst expectations! And profits are what drive the market higher! Well, sure. But eventually, the top line has to grow, too -- and that could be one heckuva problem.

What goes up must come down?
First off, it's true: As of a few weeks ago, more than 70% of S&P 500 companies that had reported second-quarter earnings beat their estimates -- surpassing the 61% average. Nice. But there is such thing as a future, and the next several quarters could see a nasty transition, as companies go from beating the Street to pounding the pavement in search of business.

Here are a few reasons why consumers and the housing market shouldn't expect green shoots just yet:

  • According to Deutsche Bank (NYSE: DB  ) analysts, the percentage of negative equity mortgages may escalate to 48% by 2011, versus 26% as of March. Negative equity is a big deal. In fact, a recent study by economist Stan Liebowitz found that it trumps unemployment, poor credit, loan resets, and other factors in precipitating foreclosure activity. While only 12% of homes in Liebowitz' research sample had negative equity, they accounted for 47% of all foreclosures.
  • Remember interest-only home loans? They're coming home to roost, as their reset monthly payments increase by as much as 75%. And that's trouble with a capital "T" for all you folks in River City. The value of active interest-only home loans sits at roughly $900 billion, according to First American CoreLogic, or nearly 9% of total outstanding mortgage debt. By year-end 2011, more than half of those loans will have reset. To heck with The Music Man, Fools -- I hear Billy Joel singing something about movin' out.
  • Finally, the Federal Housing Administration (FHA) -- whose presence in the mortgage market has swelled since 2006 -- is insuring 3.5%-down loans. With help from the soon-to-expire $8,000 tax credit for new homeowners, potential buyers can snatch up a $228,000 home with essentially no out-of-pocket contribution. In light of rising FHA delinquency rates, economic commentator Barry Ritholtz likens the phenomenon to "drinking yourself sober."

Just a party pooper?
Look, the market as a whole might not be wildly overvalued, and individual companies may soon see better days -- Caterpillar (NYSE: CAT  ) and Nucor (NYSE: NUE  ) , for instance, could enjoy a net benefit from global stimulus, even as private projects remain on hold. Alternatively, shares of Petrobas (NYSE: PBR  ) and Transocean (NYSE: RIG  ) still look like decent buys on possible future oil supply constraints

But all those who have piled into shares of Fannie Mae (NYSE: FNM  ) , Freddie Mac (NYSE: FRE  ) , and other speculative names, on the expectation that housing and consumer spending won't see another dip, should think twice. Remember, things look up and up and up -- until they don't.

Other Foolish takes on the big picture:

Petroleo Brasileiro is a Motley Fool Income Investor selection. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Mike Pienciak doesn't own shares of any company mentioned in this article. The Fool has a disclosure policy.

Read/Post Comments (1) | Recommend This Article (16)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 20, 2009, at 9:27 AM, deadlysaber wrote:

    There are only four days a year when the core fundamental data changes for a company (as far as the public is concerned)-the four earnings days. Earnings are announced once a quarter, and on that day companies come out and make statements concerning overall company health and also give projections for the future earnings. But the price of a stock changes on a daily basis. If the fundamental data alone were to determine the price of the stock, then after the initial release of data investors would rush to re-price the stock at a fair market price in line with the company's newly released fundamental data. Then the price of that stock would stay the same until the next earnings announcement, at which point the investors would again re-price the stock to the current fair market price.

    However, this is not what we see. What we see in the price of a stock is a very quick adjustment in price after earnings are released. Then every day between this adjustment and the next earnings release the price of the stock moves. For many stocks that move may be 40-60% or more of the value of the stock! So my question is this: If the core fundamental data only changes four times a year (on earnings day), what causes the price to move the other 361 days a year (holidays and weekends not included)?

    The answer is investor anticipation, generally through assumed (or speculative) circumstance. This is exactly what Charles Dow mean when he said the price discounts everything. The price, as it is reflected today, has already factored in to it the most recent changes in fundamental data. Thus, all price moves from here forward until the next release of fundamental data is not a reflection of core company value but of the speculation of the traders and investors who are expecting the price to be worth more (or less) in the future.

    As an investor this is solid information to know and understand. What it means to you is it may be useless to spend hours pouring over hard fundamental data. After all, there are high-paid analysts who do nothing but pour over that very data. In the words of one of my mentors, "What makes you so special that you are the first to see the opportunity?" (Hint: You're not!) That's why it is beneficial to move beyond fundamental analysis and analyze a stock's price behavior apart from the fundamentals alone.


    Money without intelligence is like a car without a road.

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