Earnings Expectations and Toxic Assets

Stocks have marched steadily higher since March 9. The first 10 days or so of the rally was a mad dash, which is how recovery rallies behave. But since the huge up day on March 23, stocks have settled higher. The S&P is now within spitting distance of its 2009 highs. 

There’s no doubt that investors have been pricing in some fairly optimistic expectations. And so far this earnings season is rewarding that optimism. 

Now, I’m not saying that earnings have been great. The point is, earnings haven’t been terrible. Or at least, not as terrible as investors thought they’d be back in February. 

You may recall that many analysts were saying first-quarter earnings would be when we’d really see just how bad the economy has been. It’s still early in earnings season, but we’ve heard from some important companies. I think it’s safe to say that earnings could have been much worse.    

*****Take General Electric (NYSE:GE), for example. GE stock price is down 63% form its 52-week highs. It cut its dividend and lost its AAA debt rating. That’s about as bad as it gets for one of the most respected and stable companies in the world. 

But the reality of today’s earnings report should put the rumors of GE’s demise to rest. 

Overall, GE made money in the first quarter of this year, albeit 35% less than last year’s Q1. Even its finance arm, GE Capital, which at one time was believed to threaten the very existence of GE, made $1.12 billion in three months. 

GE saw revenues rise in its energy unit and technology infrastructure division. It maintains a healthy backlog that’s actually growing. And it probably won’t need to raise any more money to maintain its capital base. 

All in all, it could have been much worse for GE. 

*****Yesterday, I suggested that the idea of the "Stress Test" for banks was really just a marketing ploy by the Treasury to boost confidence that the United States financial system is stable. After all the back-bending, and billions in bailout funds to avoid bank failures, do we really think the Treasury is suddenly going to declare any banks insolvent? 

Highly unlikely, in my opinion. 

So if the Treasury is unwilling to nail any banks, what does that mean for the Public-Private Investment Program that’s supposed to buy banks’ toxic assets? What will be the motivation for selling if there are no consequences for keeping these assets and waiting for value to return?

Well, it would appear that the Treasury is playing the "opportunity cost" card. Offer the banks a premium for these assets now that might otherwise take years to achieve. 

The banks win, as they free up their balance sheets and can theoretically increase lending. The "Toxic Investors" win, as they buy potentially valuable assets with very little of their own money while the Fed and Treasury subsidize the rest. And the taxpayer wins as Fed and Treasury loans are paid back. 

I don’t know about you, but that all sounds a little too perfect. Something’s bound to go wrong with this neat little win-win-win scenario. And I know who isn’t going to get shafted – the investors who partner with the Treasury to buy these assets. 

That’s because they simply won’t be taking on much risk at all, and they potentially make a lot of money. If you’re interested, the latest issue of Top Stock Insights just profiled three such investment houses that are participating in the Public-Private Investment Program. And we added one of these stocks to the Top Stock Insights portfolio. I’ve included all the details in a special report called How to Profit from Uncle Sam’s Toxic Asset Buy Back. Click HERE for details. 

*****On Wednesday, we watched Hovnanian Enterprises (NYSE:HOV) make a powerful breakout move through resistance. Yesterday, the stock consolidated that move. And today, it’s moving higher.
Hovnanian is now up 51% since I recommended it at $1.52. And there’s virtually no resistance before $3 a share. My only concern is that the market will turn lower before Hovnanian hits $3. Now might be a good time to put in a stop-loss order protect your gains. 

That’s it for today. Have a great weekend and I’ll talk to you on Monday.