Recently in Ahead of the Curve, I discussed a couple of catalysts that may serve as the gravitational force that pulls equity prices lower.
Over the past couple of years, the stock market has been resilient in the face of rich valuations, too much bullish sentiment, and evaporating liquidity.
However, the price action of transport stocks have started to react to demand headwinds and softening growth. Meanwhile, a strong U.S. Dollar has started to weigh on the earnings reports of multi-national conglomerates.
In addition to transportation stocks, there’s another area of the stock market I expect to come under pressure in 2015: “old-school” technology.
Many of these stocks had big runs over the last two years. But, in my opinion, their earnings quality is suspect, especially as the companies face weakening demand for their products and services.
A shining example is Sandisk (SNDK). The company pre-announced negative results and ultimately fell short of revenue targets by $100 million, leading to a plunging stock price and analyst downgrades.
Hewlett-Packard (HPQ) is another example. For more than two years, the stock has generated sustainable and quality earnings power. As a result, the stock has more than tripled.
However, the tide is starting to change. Their revenue growth has remained anemic, inventories are building, and operating cash flow has plunged relative to net income.
Finally, the International Business Machines Corporation (IBM) is a final, perfect example of poor earnings quality… but they also represent the financial engineering that we’ve seen in the stock market over the last several years.
IBM has missed revenue quarter-after-quarter for years now, often by as much as a billion dollars a quarter, all while experiencing a huge decline in free cash flow. The company has also loaded its balance sheet with debt to buy back shares and fund the dividend, hoping to prop up earnings.
Like these old-school tech companies show, poor market fundamentals are starting to catch up with stock prices. I only expect the trend to worsen as 2015 wears on.
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