Feet of Clay

The ongoing turmoil in the US credit markets appears to have snared another victim. General Electric announced 1st quarter earnings that were sharply lower than what they had led investors to expect as little as a month ago. The gunslingers, oops, sorry, the professional investors who work on Wall Street don’t like surprises, and they hammered the stock. The price for a share of GE dropped 12% on Friday, which was the largest one-day decline for GE in over twenty years. The last time GE stock dropped so much was in the stock market crash of October 1987, when the Dow Jones Industrial average dropped 25% in a single day.

The damage to earnings was apparently not caused by the industrial and high tech businesses, which are doing well. Companies all over the world are still buying jet engines, power plants, and MRI scanners. The financial services businesses in the GE portfolio did not provide the profits that had been estimated.

The guys who run GE know that Wall Street punishes surprises on the downside. So there are only two possible explanations for missing their earnings targets by so much:
1. Senior management does not know what is going on inside the company. That is, losses in GE Capital were piling up, but no one wanted to take the write off, or tell the higher ups about the losses.
2. Things turned around so much in the last two weeks of March that they overwhelmed the progress of the previous ten weeks.

Jeffrey Immelt, the CEO of GE, choose what was behind Door #2, saying: “the extraordinary disruption in the capital markets in March affected our ability to complete asset sales and resulted in higher mark-to-market losses and impairments."

These results are important because GE, due to the size and breadth of their operations, is considered a bellwether for the US, and indeed, the global economy.

Also, GE is considered an unusually well managed company, with excellent risk control. In the annual report for last year, much was made of the fact that GE had no debt that was secured by sub-prime mortgages as collateral.

If GE is having problems in the financial markets, than other banks and investment companies will be having problems as well. Even with all the announced write downs and loans made by the Federal Reserve, we’re not out of the woods yet.