Well, last week I said I expected volatility to continue, and I was not disappointed. If I were a betting man, I'd bet that Proctor & Gable beats earnings estimates just based on increased sales of Pepto Bismol. Never mind, sales from this week will hit its fourth quarter.

It looks like the stock market is concentrating on companies are beating dramatically lowered estimates and are not worring about the actual level of earnings. As of last Friday, First Call said the final estimate for third quarter earnings growth was 5.4% for the S&P 500 and actual earnings growth will be "closer to 7% than the 8% we had expected since mid-July." With the first coulple days of earning under the belt, almost 63% of reporting companies beat estimates and 76% earned more than last year. Only 11% failed to meet analysts' expectations, with 21% reporting earnings lower than last year. However, cumulative earnings are running below estimates by 1.1%. While Wall Street might be able to create the illusion of an earnings recovery, remember that last year's earnings were horrible. It was the lowest third quarter earnings for the S&P 500 since 1994 and was 35% below the prior year. Admittedly, that is operating earnings, looking at reported earnings were the lowest since 1992.

The nominal earnings growth that companies are reporting are more due to cost cutting measures and not indicative of widespread economic growth. IBM, Honeywell, and Intel are among the companies reporting earnings growth but experienced declining revenues. Most companies continue to focus on reducing cost and this mindset will not be easily swayed as companies focus on earnings growth. This will delay the continued hopes of a capital investment recovery. It will take more than increased earnings to get a capital investment recovery. Since idled capacity remains in the 20% range, there will have to be a significantly, sustainable pick up in demand before companies begin increasing capital expenditures.

In talking with some of the strategist around, the best bullish case for the economy rests on the monetary stimulus from last year combined with the record amount of refinancing will propel the economy in the fourth quarter. While the lag from monetary stimulus previously may have been 12 month, today's ease at which consumers can tap credit (read home refinancing and equity loans) significantly reduces this lag. Just looking at M3 growth over the past year can solidify that this lag has been greatly reduced. On a year-over-year basis, M3 growth has declined from 13.2% in November 2001, to 6.5% in September 2002. Not only is there building evidence that consumers are slowing their spending, but income growth is likely to slow as well putting additional pressure on discretionary expenses.

Cost cutting will also have ramifications on consumer spending. The Wall Street Journal reported that companies have been instituting broad-based salary cuts. While this might not be widespread, the days of real income growth could be over. Additionally, year end bonuses will be scarce this year.

S&P downgraded General Motor's debt on Wednesday due to concerns about its underfunded pension fund. Looking at the General Motor's pension problem, its mirrors how the economy has transformed. The U.S. used to be a great manufacturing country, but that has been replaced by a country that trades paper. GM has become a financial services firm managing money (pension fund) and creating credit (GMAC and DiTech Funding). GM finance division (GMAC) earned $476 million during the third quarter compared to $345 million from making cars. Plus GM has one of the largest investment fund to manage. Even after losing 10% of its values this year, GM's pension plan assets are about $66 billion. If it was a mutual fund it would be the largest in the country, just ahead of the $65 billion PIMCO Total Return Fund and over $10 billion larger than Fidelity Magellan.

Pension plans throughout the country are in dire shape. All the Wall Street firms have now published tomes slicing and dicing who is the worse off and who will come out unscathed. CreditSuisse FirstBoston's latest, revealed several startling findings. First of all CSFB estimates that the cumulative underfunded status of S&P 500 companies could reach $241 billion. This would be the first time it would be underfunded since 1993. There were 240 companies with underfunded pensions at the end of 2001, which was the highest level in 10 years, but could reach 325 at the end of 2002. Considering only 358 S&P 500 companies have defined benefit plans, this is quite high.

CSFB estimates that S&P 500 companies will report net pension expense of $14 billion, which is a little more than 6% of 2001 earnings. Not a huge amount on the surface, but considering the S&P 500 is boosting earning by only single digits lately, this could erase all the growth. This will not only reduce earnings, but will crimp business plans as well. Since companies will have to use real cash, unlike the journal entries used to bolster earnings previously (more on that later), companies will not be able to use the cash for capital investment, share buybacks, or pay down debt. Plus, the companies in the worse shape, the increase in pension cost will be over 10% of their earnings. The poor market returns will also cause companies to lower their assumed rate of return. It assumed rates of return are lowered 50 basis points, aggregate pension expense increases about $5 billion.

CSFB found 30 companies with pension plans that will be underfunded by more than 25% of their equity market capitalization, six have an unfunded amount greater than their equity market value. Those six are: AMR, Delta, Avaya, Goodyear, General Motors, and McDermott.

Thanks to the wonderful world of accounting rule, companies were able to claim the excess returns earned in 1999, 2000 and even 2001 as income. In 1999, S&P 500 companies claimed $2.3 billion in income. In 2000, that jumped to $12.6 billion and was $7.1 billion last year. That is expected to plummet, providing no benefit this year and adding $14 billion to expenses next year.

There are numerous other issues that are being raised concerning underfunded pension plans. Investors are starting to question if debt covenants will be violated due to increased costs or reductions in equity due to charges.

I will be taking a couple days off next week, so there will not be a commentary next week.