Why corporate earnings (and the Pope) are making markets nervous: Kohler

Wall Street analysts are having an attack of nerves over the US earnings season, due to kick off tonight – along with the G8 summit in Italy – with Alcoa’s results.

We are now getting a rethink on two levels – macro and micro.

Analysts are redoing their numbers for June quarter earnings, and coming up with less, while the world’s deep thinkers and policymakers are rethinking the rules for capitalism… and coming up with more.

The S&P 500 has now pulled back 7.7% from its intraday high on June 11 as earnings forecasts are reduced for both the second and third quarters. (The correction in Australia has been identical to that).

The average expectation is now for a 35.5% decline in second quarter earnings in the US, year on year, according to Thomson Reuters, down from minus 31.7% in April and minus 11.3% on January 1. The third quarter average forecast is now at minus 20.9%, versus 17.2% three months ago.

Australian full year earnings are currently expected to fall 20%. US and Australian sharemarkets have both fallen 30% since this time last year, which would suggest that either Australian stocks are cheap, US stocks are expensive, or that the market knows something about the prospects for Australian companies that the bottom-up analysts don’t.

In general, as a crucial earnings season approaches, there is enormous uncertainty among those whose job it is to forecast the results.

No one has lived through such a massive, simultaneous global retrenchment of consumption as this, or such wild swings in the inventory cycle or the cost of capital. In this environment of indecision, the correction that began on June 11 looks set to extend beyond 10%.

There is also enormous uncertainty at the macro level about the operation of markets and the economy, and the underlying philosophy that should apply, which is not helping the stockmarket either.

Each country individually must examine its financial structure in the context of coordinated global action, which is why this morning’s call for a new financial system review in Australia by a group of economists led by Christopher Joye of Rismark (and Business Spectator’s property blogger), is such a good idea.

They want a comprehensive financial system inquiry along the lines of the Campbell Review in 1981 and Wallis in 1996, and have listed 14 questions that need to be answered.

The global financial system, and Australia’s place in it, has probably changed more in the last 13 years than in the previous 50, and is completely unrecognisable from 1981, when Keith Campbell did his seminal review. It is definitely time for another look at it, not just in Australia but around the world, and then the results need to be integrated – by someone, somehow.

Pope Benedict XVI has also stuck his oar in, with an encyclical last night entitled ‘Charity in Truth’ (Caritas in veritate) – timed to coincide with the start of the G8 summit in Italy (appropriately being held in the earthquake ruins of L’Aquila).

Essentially, the Pope is joining the calls for a capitalism rethink: “The current crisis obliges us to re-plan our journey, to set ourselves new rules and to discover new forms of commitment, to build on positive experiences and to reject negative ones.”

And later: “Without internal forms of solidarity and mutual trust, the market cannot completely fulfill its proper economic function. And today it is this trust which has ceased to exist, and the loss of trust is a grave loss.”

Indeed it is a grave loss, although one might ask whether “internal forms of solidarity and mutual trust” will do the trick, or whether external regulation is going to be required as well. I suspect the latter.

Pope Benedict’s ideas for regulation revolve not so much around business ethics and the law, but around redistribution: “Economic activity cannot solve all social problems through the simple application of commercial logic. This needs to be directed towards the pursuit of the common good, for which the political community in particular must also take responsibility.

“Therefore, it must be borne in mind that grave imbalances are produced when economic action, conceived merely as an engine for wealth creation, is detached from political action, conceived as a means for pursuing justice through redistribution.”

He’s a smart guy Mr Ratzinger, and this papal encyclical will be influential – probably more so than the talkfest of shrinking nations in L’Aquila.

A week ago the Bank for International Settlements devoted its annual report to specific proposals for financial reform. Pope Benedict has now added a moral/philosophical overlay.

The G8 and G20 must now create a process for implementing reforms cogently and globally.

This article first appeared on Business Spectator.