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What Earnings Say About the Economy

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar. With earnings season well on its way, Morningstar's associate director of economic analysis Bob Johnson is digging through the numbers to try to pull out some implications for his economic forecast, and he is here to tell us a little bit about what he has found.

Thanks for joining me, Bob.

Bob Johnson: Good to be here.

Stipp: Bob, to start off, earnings season has seemed like it's been a little bit mix. There have been some high points and some low points so far. Can you give us a recap of what you have seen as far as the ups and the downs so far in earnings season?

Johnson: Sure. Just in terms of how it's flowed, we started out really strong with some great numbers from Intel that indicated a lot more corporate spending. We saw some decent numbers from Alcoa on the commodities side that gave people a little bit of relief there.

And then, we hit the banks at the end of last week, and the revenue growth wasn't so good. And IBM's numbers, the revenues again were a little bit light. And now this week, we've had some great numbers out of the manufacturing sector, especially today out of Caterpillar and likes, and now people are excited about the earnings again. So, we've kind of done a pendulum thing on earnings.

Stipp: Sure. So maybe some disparate data to kind of dig through and try to pull out some implications. So as you are looking company by company, what things have given you some optimism? What points, what highlights for the economy have you seen in some of the individual names. And since Caterpillar reported Thursday, let's start there.

Johnson: Yeah. I mean, I think, they had some really great numbers there, and they had some wonderful revenue growth. And probably more important than that, as I look at the economy, they talked about in the second half that they were going to step up production, because they said orders continue to run ahead of our shipments, and we are just going to have to finally bite the bullet and kick up production, and we plan to in the second half.

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Stipp: So, just a side question on the industrials. There had some concern that some of the economic indicators in the industrial space, such as the ISM, looked like they were moderating a bit, but that seems to be in some kind of a conflict with Caterpillar, or no? How do you reconcile what you're seeing in ISM and some of what you're hearing from the industrial companies?

Johnson: Sure. I think it will take a little time to work through everything, but the ISM survey is obviously asking a lot of domestic people what they are thinking. And I think, obviously, Caterpillar alluded to a lot of their strength was overseas. Not that the U.S. markets were bad, but emerging markets were at least a good part behind what they were seeing in their numbers. And I think quite a few of the industrial companies would share that their markets overseas are still pretty robust.

Stipp: Okay. Moving along to the tech side of the house, IBM was somewhat disappointing, but you saw actually some bright spots in the IBM report, in the IBM call. What did you see on that front?

Johnson: Obviously, the revenue was a little bit light there, and we did a great job on margins there, but the revenue was a little light. Now some of it was because they discontinued operations--a software company that they sold--part of it was a foreign currency effect; so that was there, and part of it was more on the services side of the house.

So, those were the discouraging things, but again, encouragingly, they made the number. They felt comfortable with their second half. And then something that's come out today is they have rolled out their new generation of mainframe computers, which is still a fairly sizable business, that will probably double in the second half versus the first half.

So there is another data point where we've got something potential or better stuff in the second half than the first half.

Stipp: A little bit more on the consumer side, Apple numbers were certainly a nice upside surprise. It just shows that people are out there buying some of the consumer electronics. What does that tell you and what implications does that have on the economic front that a company like Apple is doing so well with consumers going out there and buying these electronics devices.

Johnson: Consumer electronics has been the one really bright spot for consumer spending in general. It has been the driver, the single largest driver of consumer spending in this recovery, which is good to see. I mean, it's a luxury type of item that they are feeling a little bit more comfortable spending on. They're not buying the houses. They're not buying a lot of cars yet, and so it's good to see them spend there.

The unfortunate thing, unlike autos and unlike housing, we have to share a lot of those revenues with overseas manufacturers, if you will. While we get all of the markups on our GDP account, so to speak as a lot of the consumer electronics are actually manufactured overseas, that's the downside, and hence why the trade balance got a little worse last month, and it's one of the reasons people had to pull in their GDP numbers a bit here.

Stipp: So, one interesting thing to keep in mind on the macro fund.

So when you're looking at some of the things that may have been somewhat disappointing in the earnings reports so far, what had you seen that you would have liked to have seen maybe be a little bit better or a little bit more robust?

Johnson: Sure. I think that it's been the same in almost all the previous quarters where revenue growth was a little light from what people were looking for and margins were a little better than people were thinking. We had people beat on the earnings line and being short on the sales line, and I think there are a few things behind that. Certainly, the stronger dollar has hurt in translating those overseas sales back here, and I think that's become a little bit of a headwind and instead of the tailwind that it had been, so that certainly hurt.

Stipp: So these companies, I think, through the downturn, a lot of them have become streamlined. They are a little bit more lean and mean. This stripped down structure is certainly profitable for them, at least in the short to the intermediate term. Are they going to be able to maintain that and maybe have better profitability? Or are they going to have to build up their cost structure again to meet the growing demand that might be out there in the marketplace?

Johnson: I think they will have to build up that demand some, and I think that there is a kind of a good news, bad news there. It probably means we're going to see some slowing on the earnings growth from our corporations because they're going to have to probably step up their spending a bit. And most of them have said they will. The good news is that means more money in consumer hands, because how do you step it up? You hire more people, and that's what we've all been waiting for here. And as they get more jobs, they spend more and then we could all gear up and get this virtuous cycle going again here.

Stipp: Well, certainly sounds like something that we can hope for. Thanks, Bob. For Morningstar, I'm Jason Stipp. Thanks for watching.