Opinion: In spite of famous Truman quip, multisided economic advice best

Harry Truman, he of the pithy remarks (some too pithy for publication), had among his many quotable comments an interesting observation on what kind of economist he wanted for counsel. Tired of the equivocating answers he often heard when he asked for advice on financial matters, he said that he would like to hear from a one-armed economist. "That way," Truman said, "he can't say 'on the other hand' ... ."

Sorry, Harry, but it's necessary to talk about the outlook for corporate earnings - on both hands.

Sarbanes-Oxley, that bane of corporate CEOs and CFOs, has during the years placed an interesting twist on earnings statements. Designed for accountability and transparency, but mainly heavy on costs and labored caution, the Sarbanes-Oxley Act has resulted in earnings estimates that often appear to be carefully constructed to understate expected earnings. When actual earnings are announced, they frequently exceed Wall Street estimates.

When that happens in a positive market environment, the price of the stock will, more often than not, move higher - sometimes sharply higher. (So, if you're a CEO, better to surprise on the upside, right?)

During a positively viewed market, investors can get carried away with the numbers. Or they might put in context the numbers relative to the last quarter or the same quarter the previous year. (Oops, that's one of those "on the other hand" situations.)

Earnings also have an important partner in providing key information: revenues. When earnings "beat the street," but revenues are below investor or company expectations, what does it mean? In most cases, it means that the earnings numbers have benefited from cost cutting, and the most obvious and disconcerting method we have all been aware of is layoffs.

Unemployment is the bad news.

Here's the good news. Counter to what the media and politicians would have us believe, layoffs - ugly and undesirable though they may be - are a normal occurrence in a recession; but neither they nor the recession is without end.

Recessions of various magnitudes and causes always will be with us from time to time. They're part of the business cycle at its extreme. But they end, and when they do, positive things happen. Business begins rebuilding inventory, spending on technology to improve efficiency picks up and overtime hours increase. Ultimately, hiring returns, and unemployment declines. Note that the last positive to take place is improving employment. That's why, as we have written before, unemployment numbers will remain high as we begin moving out of the recession, and may remain high for some time. It's the last positive to fall into place, ergo its label as a lagging indicator.

These steps take time, but they will happen, and the economic cycle will turn up. That is unless Congress does severe additional damage in tampering with economic laws and fiscal reality. Feel-good populist legislation that impedes the natural forces of a free market system could do irreparable damage to this nascent recovery. (Hey, if we can have "cash for cars," how about "money for management"? My clients would love to have their fees subsidized.)

Balance the news

Although generally fairly innocuous, and sometimes even entertaining, nonstop financial coverage on TV can create for many inexperienced, and some experienced, investors such strong emotions at market extremes as to cause all reason to abandon them. Here's an example of what I mean: a client who recently fired us (yep, it happens) did so because he watched the financial news all day and evening and exclaimed, "I can't take it anymore. The stock market is going way down. Sell everything, and send me a check."

The sad aspect of this person's decision is the fact that he had no stocks, only short- and intermediate-term bonds in his portfolio. There was no exposure at all to the stock market, a fact we explained to him to no avail.

The emotion converted reality to fear, the opposite of what happened during the tech bubble when rationality was replaced by extreme greed - just before the Nasdaq collapse.[[In-content Ad]]Clark Davis is a 37-year investment veteran and CEO of St. Louis Investment Advisors, a specialized money-management company. He can be reached at cdavis@slia.com.