Friday, August 27, 2010

Bumpy Ride in the Stock Market


Whoops!
If you have kept up with Q2 earnings, you may have heard that Intel (Ticker: INTC) had a blow-out Q2 and earnings were awesome.  From that report, Intel raised outlook for Q3, lifting expected revenues to $11.6 billion, when estimates at the time were at most $11.3 billion.  But today, just a bit over 1 month after the earnings, Intel announced in a press release that they were going to miss the estimates, lowering revenue expectations to $10.8 to $11.2 billion.  Can you say, "whoops"?

What this tells us is that their sales had great momentum up to the point when they released their earnings in the middle of July, and quickly saw a reversal as Q3 progressed.  Intel is a big company and a large majority of computers use their processors.  If Intel says sales are slowing, it likely means the economy is slowing as well.

Double Dip - Here We Go Again?
Is this not contradictory to what I just wrote yesterday about the stock market not going to go into a double dip?  Well, not exactly.  I argued that the stock market was not going to see the levels that were reached in March of 2009.  I still believe in that.

From my conversations with my close friends, I have noted how the economy appears to be a system with a very slow or long time constant (here's the engineer in me starting to take over).  A what, you ask?  To put it simply, it's something that reacts very slowly to a stimulus, like an electric stove.  If you switch on your stove to its maximum setting, it probably eventually heats up to somewhere around 200°C, but it doesn't actually get there too quickly.  You can put on your finger on the coil for a few seconds before you need to remove it.  That's a long time constant.  And, say you wanted to fry an egg.  You know that if you leave the heat on "max" for too long, you're going to totally ruin your breakfast, but you still go ahead and turn the knob to "max" when you first start cooking.  Why is that?  Well, it's the same reason. It's because the time constant of the stove is too long. You want to get it up to the temperature quickly, so you don't set it to "medium" right off the bat.  You use the "max" setting for the first little bit, and when your cooking intuition tells you that the heat is now too high, you turn the knob back down to "medium".  If your cooking intuition is similar to mine, chances are you'd turn the knob down a little too late, and the temperature of the stove shot way above what you needed, and the egg white turns into "egg black".  This is typical of a system with a slow response.  It is hard to control and often overshoots where it needs to be.

Sorry...what were we talking about?  Yes, the economy having a slow time constant.  What is happening now, I guess, is that our economy was turned to the "max" setting in March 2009.  All of a sudden, everyone started to spend again and the economic numbers were awesome for a bit over a year.  Intel confirmed that when it came out with a great quarter and raised outlook.  Then, reality set in and people start to realize that they may have been a little too optimistic and turn the knob back to low, realizing how the economy had shot up too high.  We are now in that "low" setting.

What Happens Next?
As I said, the economy is slow reacting.  What will happen in the short term will probably not be too encouraging.  You will continue to see signs of a down turn.  The slow reacting economy has begun a downward motion, and it will take some time for it to reverse its course.  When that will be is anyone's guess.

Is it time to sell or a time to buy?  I'm no good at picking the right time to buy or sell.  So, I'm going to stick to accumulation of good quality companies if the prices are right.  And for many companies right now, I believe the prices are very right.  Do your homework and buy with a margin of safety/error.