By Michael Lombardi, MBA for Profit Confidential

As of April 26, more than half of the companies in the S&P 500 issued their corporate earnings for the first quarter of 2013. By no surprise, and as I have been warning in these pages, only 44% of them were able to beat the sales estimated by Wall Street analysts. (Source: FactSet, April 26, 2013.)

Pfizer Inc. (NYSE/PFE), a major drug maker in the S&P 500, reported a nine-percent decline in revenues in the first quarter. But in spite of its decline in sales, this S&P 500 company was able to post a 58% increase in corporate earnings.

One can't help but wonder how it can be possible to show better corporate earnings on declining sales.

As I have been harping on about in these pages, companies in key stock indices, like the S&P 500, are able to show better-than-expected corporate earnings through a financial engineering technique called stock buybacks. While S&P 500 companies aren't selling more of their goods or services, of those that have reported their corporate earnings so far this season, a surprising 73% of them were able to beat estimates.

International Business Machines Corporation (NYSE/IBM), a technology giant in the S&P 500, reports that worldwide sales fell for the company in its latest quarter; sales plummeted seven percent in the Asia-Pacific region, its services business saw a decline of four percent, and hardware sales dropped 17% in the first quarter of 2013. (Source: CNN Money, April 18, 2013.)

But International Business Machines (IBM) announced it will buy back an additional $5.0 billion worth of its own shares, in addition to the $6.2-billion share buyback plan already in place. (Source: Associated Press, April 30, 2013.) The more stocks the company buys back, the more it can prop up its per-share earnings.

By decreasing the number of shares a company has outstanding, corporate earnings per share automatically increase, even if corporate profits have not changed.

Looking ahead, as the S&P 500 companies reported their corporate earnings for the first quarter, they have started warning about their future earnings growth. So far, 48 companies have issued negative corporate earnings guidance for the second quarter of 2013.

The higher key stock indices rise, and the more the optimism towards them increases, the more skeptical I become. As lackluster as it is, caution and capital preservation seem to be two good choices for now.

Michael's Personal Notes:

For the first time in six years, the U.S. federal government expects to reduce its national debt by $35.0 billion, which is set to happen in the third quarter of its fiscal year (April?June 2013). (Source: Wall Street Journal, April 29, 2013.)

But at the same time that the U.S. Department of the Treasury reported it will pay off this insignificant portion of the national debt, it also said that the government expects to borrow another $233 billion in the last quarter of fiscal year 2013 (July?September 2013).

The Congressional Budget Office (CBO) expects the government will hit a budget deficit of $845 billion by the end of this fiscal year. But at the end of March, the budget deficit of the U.S. federal government had already hit $600 billion. Hence, I'm expecting 2013 to be the fifth consecutive year of trillion-dollar-plus deficits for the U.S. government.

I hate to put it in these words, but like a drunk who thinks he doesn't have a problem, the problem can't be solved until it's realized. The politicians and central banks continue to tell us that the government increasing its budget deficit and the Federal Reserve continuing to print new paper money is leading the U.S. economy towards growth?but is it true?

I beg to ask the question: how long can we continue to borrow at this pace and increase our national debt and consider it all to be sustainable? Can we borrow at this pace five years down the road without making any fundamental changes? I highly doubt it.

Right now, the Federal Reserve is keeping the U.S. government afloat by buying the debt the government issues. For citizens, the oversupply of dollars and rising national debt is killing their buying power. Inflation is becoming a problem.

In February, the U.S. Producer Price Index (PPI), what many economists consider to be an early signal of where inflation might be headed, posted the highest month-over-month rate of change since October 2012. The PPI rose 0.7% in February from January. (Source: Bureau of Labor Statistics web site, last accessed April 5, 2013.) Using February's number as a base, the PPI is rising at an annual rate of 8.4%. (See "Producer Price Index Soars to Annual Rate of 8.4%; Government Says No Inflation.")

In the first quarter of 2013, real personal disposable income (the amount of money the average American has after paying taxes) decreased 5.3% compared to the same period of 2012. (See "American Real Disposable Income Collapses in First Quarter of 2013.")

Rapid inflation?maybe even hyperinflation?will be the end result of all this government borrowing and Federal Reserve paper money printing.

What He Said:

"As investors we need to take a serious look at our investment portfolios and ask, 'How will my investments be affected by an American grown recession?' You should take what precautionary steps you can right now to protect yourself from a recession in 2007. Maybe you need to cut your own spending or maybe you need to sell some stocks that will take a beating during a recession. You know what tidying up you need to do. Don't procrastinate... get to it now. And please remember: Recessions can happen quickly, stock markets don't go up during recessions, and the longer the boom before the recession, the longer the recession. Just based on my last point, we have plenty to worry about in 2007." Michael Lombardi in Profit Confidential, November 13, 2006. Michael was one of the first to predict a U.S. recession, long before Wall Street analysts and economists even thought it a possibility.

Re-published with permission.

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