Posts Tagged ‘Corporate Earnings’
Saturday, July 21st, 2012
Emerging Markets Radar (July 23, 2012)
- China’s big four banks made about Rmb50 billion of new loans in the first half of July, double the amount in June, Shanghai Securities News reported. Additionally, China’s outstanding real estate loans were up 10 percent year-over-year in the first half of the year.
- China is boosting this year’s railway investment plan by 9 percent to Rmb 448.3 billion ($70.3 billion).
- Turkish white goods manufacturers continue to gain market share, with sales increasing by 5 percent year-over-year in June. Domestic sales were up 3 percent to 634 thousand units, while exports were up 15 percent to 1.43 million units.
- On July 19 the Ministry of Land Resources and Ministry of Housing and Urban-Rural Development jointly held an urgent video conference with local governments on how to prevent a rebound of home prices, and asked them to increase land supply for ordinary residential units. Although it had prompted negative sentiment toward the property sector, the government didn’t issue new policies to slow housing transactions, which are vital to investment activities.
- China’s Premier Wen Jiabao warned that the economic rebound isn’t yet stable and hardship may continue for a period of time.
- Borrowing costs in the Czech Republic are to remain low after Moody’s reaffirmed the country’s A1 rating this week with a stable outlook, four notches above Italy and five above Spain.
- With the trade deficit on a downward path and inflationary pressures diminishing, BMI expects that the Reserve Bank of India has sufficient space to resume monetary easing.
- In its July 17 report, Citi Research says China’s economic rebalancing is positive to the economy and the market in the long term, but should introduce uncertainties in corporate earnings amid slower growth and reforms in the near term. It points out that slow investment and the de-capacity process will likely bring gains for telecommunications, staples, health care, utilities, transportation, discretionary and property.
- Although China is adding investments to help stabilize economic growth, the country still intends to reduce the weight of investment in the GDP. Sectors that are related to or relying on investments may see sales and earning growth being revised downwards going forward.
- Trade figures published by the Bank of Thailand in July indicate that exports are falling short of consensus expectations for a robust recovery in 2012.
- BMI revised its forecast for Mexico’s average inflation from 3.6 percent to 3.8, as a recent outbreak of bird flu has driven up egg and poultry prices in the country, while a growing concern over the drought in the U.S. has caused grain prices to spike.
Tags: Bank Of India, Corporate Earnings, Downward Path, Economic Rebound, Goods Manufacturers, Inflationary Pressures, Land Resources, Local Governments, Ministry Of Housing, Negative Sentiment, Premier Wen Jiabao, Property Sector, Real Estate Loans, Rebalancing, Reserve Bank Of India, Residential Units, Shanghai Securities News, Stable Outlook, Time Opportunities, White Goods
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Sunday, July 15th, 2012
Last week the S&P erased 6 days of consecutive losses in 30 minutes of trading on the back of news that JPMorgan lost at least 25% of its average annual Net Income in one epic trade, and stands to make far fewer profits in the future, even as the regulators are about to fire a whole lot of traders for mismarking hundreds of billions in CDS. This was somehow considered “good news.” This being the “new normal” market, where nothing makes sense, and where EUR repatriation as a result of wholesale asset sales by European banks drives stocks higher, we were not too surprised. Sadly, even in the new normal, things eventually have to get back to normal. And that normal will come as corporate earnings are disclosed over not so much over the next 3 weeks, when 77% of the companies in the S&P report Q2 results, but in the 3rd quarter. Why the third quarter? Simple: as Goldman’s David Kostin explains, “consensus now expects year/year EPS growth to accelerate from 0% in 2Q, to 3% in 3Q to 17% in 4Q.” Sorry, but this is not going to happen, and as more and more companies preannounce on the back of the global slowdown which many has seeing US GDP down to 1.3% in Q2, and sliding further in Q3 absent some massive QE program out of the Fed, it is virtually guaranteed that the unchanged Earnings precedent that Q2 will set (and there is a very high probability that Q2 2012 will mark the first YoY drop in earnings since the unwind Great Financial Crisis) will continue into Q3 and likely Q4. Because, sadly there simply is no catalyst that will drive revenues higher, even as margin contraction was already set in.
All of this also means that the only possible driver of S&P growth in Q3 (of which we are already 2 weeks deep into) and Q4 will be multiple expansion. This, however too, will be a disappointment. Again from Kostin:
We believe P/E multiple expansion is unlikely in 2H. Headwinds include the fast-approaching Presidential election, associated policy uncertainty, and the looming “fiscal cliff” that everyone outside the beltway decries but no one in Washington, DC seems willing to seriously address.
Not to mention the debt ceiling which is still on track from making US landfall sometime in the next 3 months.
So while short covering rallies are fast and furious, corporations -that traditional deus ex to justify US “decoupling” – now have only one fate before them: disappointment.
Which leaves the Fed. Sadly, not even the extension of Twist can do anything about the biggest concern that banks are currently facing, namely the accelerated decline in reserves, as a result of the prepayment of Maiden Lane obligations and the gradual drop in FX swaps (at least until the next time Europe needs a Fed-based bail out that is). As can be seen in the chart below, Adjusted Reserves have tumbled to level not seen since December, and then May of 2011, both times when the market was about to turn over if not for global coordinated central bank intervention.
Full note from Goldman:
Our 2012 investment thesis for the US equity market has three pillars: a stagnating economy, static P/E multiple, and minimal earnings growth.
First, weak macro data and three proprietary Goldman Sachs indictors support our view of a lackluster economy. The Goldman Sachs Current Activity Indicator (CAI) shows the US economy growing at an annualized pace of just 1.3%. The three-month moving average of our Earnings Revision Leading Indicator (ERLI) diffusion index, a measure of 29 separate micro-driven industry data points, remains below trend at 41, consistent with a softening of our Global Leading Indicator (GLI). On the macro front, the June ISM report slipped to 49.7, the first sub-50 print in three years.
Second, we believe P/E multiple expansion is unlikely in 2H. Headwinds include the fast-approaching Presidential election, associated policy uncertainty, and the looming “fiscal cliff” that everyone outside the beltway decries but no one in Washington, DC seems willing to seriously address.
The third leg of our three part framework will come into clarity during the next several weeks as firms report 2Q results and offer guidance on business activity for the second-half of 2012. 80% of S&P 500 market cap will report between July 16th and August 3rd. Firms to watch next week include: BAC, C, GE, IBM, JNJ, KO, MSFT, PM, SLB, and VZ.
We expect a modest quarterly earnings miss. A shortfall in sales rather than margins will be the primary culprit. Firms will struggle to meet revenue forecasts given weak global demand and a strong US Dollar. Consensus margin expectations are already flat or negative in most sectors.
Bottom-up consensus currently forecasts flat year/year EPS growth, driven by a 4% increase in sales and a 40 bp fall in margins to 8.9%.
Five sectors are expected to post negative earnings growth in 2Q 2012 compared with 2Q 2011: Energy, Materials, Utilities, Consumer Discretionary and Consumer Staples. Analysts forecast Materials and Energy will both post year/year EPS declines of 12% reflecting the sharp fall in commodity prices during 2Q, with Brent plunging by 16% and copper dropping by 10%. In contrast, Industrials and Information Technology will report EPS growth of 7% and 11%, respectively. Apple (AAPL) will again be a standout performer with year/year sales and EPS growth of 32% and stable margins of 25.6%. Including AAPL, the Tech sector is forecast to deliver sales and EPS growth of 9% and 11%, respectively. Without AAPL, the sector will post revenue and EPS growth of 6% and 7%, respectively.
2Q results will affect the market’s outlook for earnings in 2012 and 2013. Consensus now expects year/year EPS growth to accelerate from 0% in 2Q, to 3% in 3Q to 17% in 4Q. Consensus forecasts full-year EPS growth will double from 7% in 2012 to 14% in 2013. In contrast, we do not forecast a steep 4Q 2012 inflection and anticipate EPS growth climbing from 3% in 2012 to 7% in 2013.
Our full-year 2012 and 2013 S&P 500 EPS forecasts remain $100 and $106. Current bottom-up consensus equals $103 and $117. Consensus 2012 estimate has dropped from $107 in January and from $114 in August 2011.
Earnings season focus points: (1) domestic demand; (2) international weakness; (3) margins; and (4) losses from JP Morgan’s CIO unit.
Our ERLI Diffusion Index suggests US micro data improved in June but the three-month moving average remains below trend at 41. In May, our diffusion index of micro driven, industry-level data points fell to 29, the lowest reading since April 2009 (a reading of 50 implies “trend” growth). However, data rebounded in June producing a slightly above trend reading of 53, with 23 of 29 industry variables increasing at a trend or better pace. Examples include hotel occupancy, rail car loadings, and NY/NJ port activity. If this trend persists, it implies that the micro data points which inform equity analysts’ earnings projections may not be as poor on a near-term basis as an otherwise gloomy macro picture suggests. In contrast, our macro driven Global Leading Indicator of industrial production has been contracting at an accelerating rate for the last three months, which our research has shown augurs poorly for S&P 500 returns.
Margins will once again be source of scrutiny. Margins have stabilized at 8.9% for more than a year after having surged by 300 bp from a cyclical low of 5.9% in 2009. Differing margin forecasts explain 80% of the gap between our top-down EPS estimate and bottom-up consensus for 2012. Consensus expects margins to remain flat during the first three quarters of 2012 before rising sharply starting in 4Q and expanding to 10% by year end 2013. In contrast, we forecast margins will hover around 8.9% for the next two years.
JP Morgan CIO trading losses. This morning JPM reported 2Q EPS of $1.21, 59% above consensus expectations of $0.76. Of course, analysts had cut estimates by 38% since May after the bank disclosed large trading losses in its chief investment office. The JPM CIO losses of $4.4bn reduce 2Q 2012 EPS for the S&P 500 by $0.49. For the Financials sector, year/year EPS growth in 2Q is anticipated to be 8% including JPM and 12% without.
Tags: 2q, 3q, 3rd Quarter, Asset Sales, Consecutive Losses, Contraction, Corporate Earnings, Earnings Season, European Banks, Financial Crisis, Global Slowdown, Goldman, Kostin, Net Income, Nothing Makes Sense, Q3, Q4, Qe, Repatriation, S David
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Wednesday, July 11th, 2012
Could “Confidence” Add 50 Percent to the Stock Market?
by James Paulsen, Chief Investment Strategist, Wells Capital Management
Fear (a lack of confidence) has dominated the economic and investment climate since the 2008 crisis. Indeed, excessive fears during the crisis likely accentuated the magnitude of the economic collapse far more than did poor economic fundamentals alone. Similarly, the inability to revitalize confidence since has also hampered both the economic and stock market recoveries.
A culture devoid of confidence has proved a chronic liability during the last five years. However, could a slow but steady revival in confidence soon become a primary asset driving stock prices higher? For a third time in the post-war era, since 2008, the U.S. stock market has traded below its long-term trendline level (that is, the level of the stock market if it rose through time at a constant pace equal to its long-term average return). While the slope of the stock market’s trendline tends to approximate the sustainable earnings growth rate, the degree to which the stock market trades above or below its trendline level has depended primarily on economic confidence. As shown below, should confidence simply rebound to a normal recovery level in the next several years, the return of the U.S. stock market may be boosted by 50 percent!
Post-War U.S. Stock Market vs. Trendline
Charts 1 and 2 compare both the U.S. stock market and U.S. corporate earnings relative to their respective post-war trendline levels. In each case, the trendlines are calculated by a simple regression of the (natural log) level of the stock market or profits against time. The slope of each trendline is a proxy for the average annualized growth rate over the entire period. Not surprisingly, since stock prices respond to earnings, the trendline slope of corporate profits and of the U.S. stock market are nearly identical at about 7 percent. And, 7 percent is very close to the annualized growth in nominal GDP—since 1949, nominal GDP growth has averaged about 6.7 percent overall. Essentially, over long periods of time, earnings cannot grow faster than overall economic growth and the buy and hold price only return from the stock market approximates the long-term pace of earnings growth.
Is Historic Earnings Trendline a Good Guide to Future?
In the post-war era, the annualized total return from stocks has been about 11 percent comprised by about 7 percent earnings growth and about 4 percent dividend returns. As shown in Chart 1, however, in the last decade, the stock market has significantly trailed relative to its trendline. Is the old trendline growth rate of about 7 percent still a reasonable expectation for the future?
Certainly, U.S. balance sheets are more leveraged today and the savings rate has been far lower in recent years compared to earlier in the post-war era. Moreover, aging U.S. demographics almost ensures slower labor force growth in future years (a moderating force for overall economic growth) unless immigration policy is considerably liberalized. Alternatively, in the last couple decades, the global economy has created a fabulous new economic growth booster—functioning emerging world economies! So far, these new economic entities have mainly augmented supply capabilities but several are on the cusp of becoming burgeoning middle class economies which should dramatically boost global demand and perhaps help maintain global economic growth rates even as developed economies age.
Most encouragingly, however, as shown in Chart 2, U.S. earnings continue to follow the long-term trendline established throughout the post-war era. Despite noticeably slower average GDP growth in the U.S. since 1985, earnings growth has continued to approximate its historic long-term trendline. Indeed, despite the pronounced and ongoing concerns surrounding the contemporary recovery, U.S. earnings bounced quickly above trendline after the recession and have since risen in line with trendline growth. Overall, earnings show no signs yet of breaking below long-term results suggesting the long-term trendline for the stock market may remain near post-war norms.
The Valuation of the Earnings Trend
Although stocks are ultimately tethered to earnings, in the short-run, the stock market often trades at a premium or discount to its trendline. As illustrated in Chart 1, the difference between the stock market and its long-term trendline is a good proxy for investors’ valuation of the long-term earnings trend. Since 2008, for the third time in post-war history, the U.S. stock market has traded persistently “below” its trendline. This also occurred after WWII until the mid 1950s, and again between the early 1970s until the late 1980s.
This is also illustrated in Chart 3. What causes investors to value the earnings trend sometimes at a 25 percent (or more) premium and sometimes at a 25 percent (or larger) discount? Certainly, multiple factors comprise this complicated valuation. During the late 1940s, the discount to trendline seemed to be driven by a post-war inflation surge, in the 1970s escalating inflation and interest rates appeared to lower valuations, and in the contemporary period persistent anxieties surrounding the potential for a global financial calamity have dominated. By contrast, the huge premium paid by investors for trendline earnings in the 1960s coincided with attitudes reflected in the “Camelot Kennedy Years” while the record-setting premium valuation reached in the late 1990s was a product of a “new-era” mania.
Confidence & Valuations
As shown in Chart 4, the discount or premium valuation of the stock market relative to its trendline is perhaps best explained by economic “confidence.” This chart overlays the percentage differential of the stock market relative to its trendline with the consumer confidence index. Although not a perfect relationship, the level of confidence has done a good job tracing changes in the “valuation of the earnings trend” during the post-war era.
Since at least 1950, premium and discount valuations of the stock market to its trendline have corresponded closely with periods of strong economic confidence and periods of broad economic fear. Currently, U.S. economic confidence is hovering in the lowest quartile of its post-war range and the U.S. stock market is about 25 percent below its trendline. This is not a coincidence. As was the case in the late 1940s, early 1950s, and again in the 1970s, early 1980s, a slow but steady revival in U.S. confidence could represent the biggest driver of stock market performance in the next several years!
An Investment Possibility?
The confidence index illustrated in Chart 4 has oscillated between about 60 and 110. With the exception of the late 1990s when the index briefly reached above 110, “normal” economic recovery confidence peaks have been around 100. Stock investors should consider what could happen should confidence slowly recover to normal again in the next five years eventually reaching a level between 95 and 100. Using history as a guide (reading across to the left scale in Chart 4), if confidence returns to normal, the stock market would likely trade at a 25 percent to 30 percent premium to its trendline level.
Of course, in five years, the stock market trendline level will also be higher. If the historic trendline growth rate remains a good guide for the future, the trendline (the dotted line) in Chart 1 would rise by about 7 percent a year in the next five years suggesting a trendline by 2017 of about 2425. However, to be conservative, assume in the next five years trendline earnings only grow at a pace of 3 percent, significantly “less” than the long-term trendline growth rate of 7 percent. Currently, the S&P 500 trades at about 1350 and its trendline level (from Chart 1) is about 1800 (i.e., 25 percent higher than the S&P 500 current price of 1350). With these assumptions, the stock market trendline would rise by 16 percent in five years to about 2100!
Finally, from Chart 4, assume confidence improves from its current level to about 95 boosting the investor valuation of the trendline from its current 25 percent discount to about a 25 percent premium in five years. A trendline target in five years of about 2100, combined with a valuation premium of about 25 percent implies a target price for the S&P 500 of about 2600—nearly a double from today’s level!
While we are not forecasting a doubling of the stock market during the next five years, this analysis does highlight the longer-term upside potential from stocks which exist today solely because of widespread cultural fears. Chart 3 shows the stock market has a historical tendency to oscillate between periods of glee and gloom.
The eventual impact of the Great Depression and WWII on investor attitudes kept the stock market selling at a discount until the late 1950s. By contrast, the cultural euphoria which swept the country during the baby-boom years kept stocks oscillating about a 25 percent premium between the late 1950s and the early 1970s. The stock market could be bought at a 60 to 70 percent discount in the 1970s when runaway inflation and interest rates destroyed confidence. Twenty years later in the late 1990s, investors could not buy stocks fast enough in the “new-era” even though they paid a 60 to 70 percent premium! Since 1945, two bouts of cultural glee (1960s and 1990s) subjected investors to significant risks while recurring bouts of cultural gloom have treated investors with three remarkable “fire sales”—1940s, 1970s, and “today”! Stock prices will continue to oscillate and scary sell-offs will occasionally feed fears, but don’t miss this sale!
Tags: Chief Investment Strategist, Corporate Earnings, Corporate Profits, Earnings Growth, Economic Collapse, Economic Confidence, Economic Fundamentals, Investment Climate, Lack Of Confidence, Post War, Simple Regression, Slope, Steady Revival, Stock Earnings, Stock Prices, Third Time, Trendline, Trendlines, U S Stock Market, Wells Capital Management
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Thursday, July 5th, 2012
Confused by all the amusing arguments of a housing “recovery” (because if you believe in it, it just may come true…. maybe) in the sad context of a reality in which the economy is once again turning from bad to worse missing expectations left and right (for every report surprising to the upside, two do the opposite), corporate earnings and margins have rolled over, US states and cities and European countries are filing for default or demanding bailouts at an ever faster pace, and only headlines such as “stocks rise on hopes of more central bank easing” appear in the good news columns of mainstream media? Don’t be: David Rosenberg explains it all.
HOUSING DATA SKEWED BY “UPSIDE-DOWNERS”
What is really driving whatever recovery we are seeing in terms of home sales and prices are the units that are so ridiculously priced — like at less than $125,000. These are where the multiple offers are coming into the fore — and then to be rented out. The reason is that this is the only part of the market that is truly “tight” because almost 30% of American homeowners either have no equity in their homes or less than 5% skin in the proverbial game (according to CoreLogic). These folks have to write their lenders a cheque to make a sale, so many are holding out until they can get a better price and the all-cash deals being placed by investors are allowing for this (note too that 45% of the nation’s homeowners have less than 20% of equity in their homes).
According to data cited by the USA Today, the supply backlog where over half of homeowners are “upside down” on their mortgage is at 4.7 months’; in areas where “upside down” borrowers make up less than 10% of the market, the listed inventory is closer to 8.3 months’ supply — it is in this mid-to-high end where prices are still vulnerable to downside potential — this is not the sliver of the market where vulture funds are looking to pick up a cheap unit to then rent out to the “boomerang” crowd.
As the charts below visibly illustrate, it is probably a little early to be celebrating the recovery in the U.S. housing market, despite the exuberance in the homebuilding stocks which only capture a small share of the overall industry. The market is healing to be sure, but is far from healed. Look at these graphs and draw your own conclusions.
Tags: 7 Months, American Homeowners, Backlog, Boomerang, Borrowers, Cheque, Corporate Earnings, Crowd, David Rosenberg, Downside, Economy, European Countries, Lenders, Mainstream Media, Margins, Months Supply, Mortgage, Pace, Sliver, Stocks, Usa Today, Vulture Funds
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Thursday, May 24th, 2012
by Mike Boyle, Advisors Asset Management
From 4/2/12 through 5/18/12 the S&P 500 lost 8.73%. This marks the18th time since 3/9/09 (the beginning of the current bull market) that the S&P 500 has corrected by at least 3% and the eighth time that the S&P 500 has corrected by at least 7%. In addition, our research of the last 50 years shows 3% pullbacks occur on average four times a year. So, clearly pullbacks are commonplace during a normal bull market; however, every time they occur they still set investor emotions on edge and test their resolve. At times like this we like to try and decipher what drove the selloff and try to resolve if we think it is just a normal correction or the beginning of a longer trend down and possibly the start of a new bear market.
In late March, we highlighted that the equity markets appeared to be due for a correction and consolidation as the run from the 10/3/11 bottom seemed unsustainable and the equity markets appeared overbought. April then began with a mild selloff (-4.26%) but then it traded back towards its near-term high in late April and early May. However, as May progressed investor appetites soured and the equity markets turned south again driven by seasonality fears (Sell in May…), banking concerns (JP Morgan’s trading loss) and worries over the viability of the Eurozone due to the recent elections in France and Greece. On their own, any one of these factors was enough to push the market lower and together they drove a pretty strong selloff of 7.87% for the S&P 500 (5/1/12 – 5/18/12). Yet it wasn’t all bad news, but the good news on corporate earnings and U.S. economic strength was just that, good news, and the markets were in need of great news to help stem the short-term tide.
Some of this good news includes an earnings season that is, statistically, better than last quarter. In addition, EPS (Earnings Per Share) for the S&P 500 has risen over 10% year-over-year and is expected to grow about the same over the next year. On the value side the P/E (Price per Earnings) for the S&P 500 now sits at 13.29 well below its value of 15.32 from a year ago and its 60-year average of 16.4. Other good news includes reports of home inventories shrinking over 20% year-over-year, existing home sales rising and vehicle sales hitting levels last seen four years ago. This reinforces our thesis that the U.S. economy is continuing to mend (albeit slowly) and should continue to do so and should be helped along the way by the positive feedback cycles we are beginning to see from a number of industries including housing and autos.
Will there be more bumps in the road and more gut check moments? Absolutely! However, we still like the outlook for equities and are standing by our end-of-year target of 1430 for the S&P 500. We would continue to recommend investors take advantage of the dips as they come (disciplined dollar cost averaging if they can) and would favor our themes of investing in companies and strategies that offer quality dividends, quality balance sheets and quality (above trend) growth.
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at ~/blog/about/disclosures. For additional commentary or financial resources, please visit www.aamlive.com
Copyright © Advisors Asset Management
Tags: Appetites, Bad News, Bear Market, Corporate Earnings, Earnings Per Share, Earnings Season, Economic Strength, Eighth Time, Elections In France, Eurozone, Great News, Gut Check Time, Jp Morgan, Last Quarter, Mike Boyle, Pullbacks, S Trading, Seasonality, Selloff, Viability
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Thursday, April 26th, 2012
by Jeff Miller, Dash of Insight
If you are reaching an important investment decision, I have a suggestion for you:
Insist on data — accept nothing less!
Investors should monitor diverse sources of investment information to avoid confirmation bias. If you want to succeed, you still need to engage in critical thinking. Some are in complete denial about progress. There is a simple solution if you do not like the reality of strong corporate earnings:
Talk about “normalized earnings.”
This has a wonderful scientific feel to it, lending an air of credibility to those who have not studied the subject. After all, don’t we want our estimates to be “normal?”
If the current strong earnings reports do not fit your forecast, you can just say that you want to “normalize” earnings without offering any clue about your method or how it has worked in the past.
When the recession hit, there were many observers who felt that even the finest companies would be crushed by the economic collapse. They expected that revenues would fall, expenses would increase, and profit margins would collapse.
Some of us thought that the best companies — not all — would learn to get “lean and mean” and would increase earnings rapidly during the rebound. We were right, and we have profited from this investment.
The increased earnings had a downside, since it often came at the expense of workforce reductions, with remaining workers asked to do more.
During the recovery period, the companies with enhanced productivity have blossomed — better earnings and better cash flows. There is a clear lesson:
Profit margins went higher as pricing power and employment went lower.
I disagree with some observers (sometimes accused of being perma-bulls) who think that profit margins have achieved a permanently higher level. My own conclusions are more nuanced. I fully expect profit margins to decline, and I am interested in two questions:
- How far?
We should all be open-minded about the eventual profit margin level, which is a function of (primarily) new competitive entrants. When it comes to a topic like — for example — unemployment — the bearish pundits are eager to embrace the idea that there have been structural changes. OK — and what about the many companies that are protecting their profit margins?
More importantly, I agree with the general concept that profit margins will decline. At the same time this “mean reversion” occurs I expect all of the things we associate with a strong recovery: Better employment, better pricing power, and more aggressive competition from new companies.
There is nothing surprising about any of this, since it reflects a typical business cycle.
Time to call “FOUL!”
There is a group that I’ll call Pundits in Denial. They engage in static analysis, expecting profit margins to decline while nothing else changes. As a result of this misguided analysis they help to scare the daylights out of the average investor by stating that if earnings were “normalized” —what a wonderful word!! — then the market is massively overvalued.
How to Normalize
When I am analyzing a stock with cyclical properties, I definitely consider the earnings at peaks and troughs of the business cycle. This is one of the key elements of my edge, so most people have no idea about how to do this. If you are at a business cycle trough, you must be willing to buy cyclical stocks at a high P/E multiple — and vice versa.
To do this correctly you need to have a good theory of the business cycle and where we are right now.
You cannot just take a meat cleaver to earnings, saying that you reject the data because of profit margins.
If you want to gain an investment edge you have to find something that most people are doing wrong. Investing in cyclical stocks combines common errors on profit margins, economic strength, and where we are in the business cycle.
I have a current emphasis on this theme, but today presents an outstanding candidate in Caterpillar (CAT). I had several stocks in mind for this article, but CAT is the most timely. I am choosing it as the worst-performing (and therefore the best opportunity) of stock fitting this theme, since the stock sold off today despite a good report. Here is the long-term earnings picture (from the excellent fastgraphs source) before today’s report:
Any investor who looks at this chart for a minute or so will be far ahead of most of the people they see in TV! You can see for yourself the worst case of earnings during recessions, the general growth rate, the ability of the company to deal with recessions, and the current potential.
Nothing in today’s report upset this story, so you get a chance to buy a terrific stock at a discount.
Once again, I abbreviated this story to cite the stock with the best current opportunity. Another candidate to feature in this story was Apple, but that would have been a layup! I hope readers understand that there are many, many stocks like this.
To repeat the main point — “normalizing” profits is not as obvious as it first seems…..
More to come.
Copyright © Dash of Insight
Tags: Bulls, Clue, Conclusions, Confirmation Bias, Corporate Earnings, Credibility, Critical Thinking, Denial, Downside, Earnings Reports, Economic Collapse, Investment Decision, Jeff Miller, Observers, Profit Margins, Rebound, Recession, Recovery Period, Simple Solution, Workforce Reductions
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Wednesday, April 11th, 2012
With the election season upon us, have you been wondering what the stock market will do in a presidential election year? To be sure, no one has the answer, but looking at stock market performance during election years can provide some helpful insight.
Election year market cycles
Historical data suggest that the stock market and presidential election years follow predictable patterns and traditionally result in better performance if the incumbent party wins. A look at the historical returns of the Dow Jones Industrial Average (DJIA), the oldest equity market index that tracks 30 significant stocks, helps illustrate this point.
Over the past 29 presidential election years since the Dow was first published in 1896, the index has delivered an average return of 7.18%, slightly off from the average of 7.35% seen in a non-election year according to Dow Jones Indexes. Keep in mind that this data represents past performance and there’s no guarantee that patterns and results will continue in the future.
The political landscape
Generally, investors haven’t suffered big losses during election years. However, the market did decline as recently as the last U.S. presidential election in 2008 during the financial crisis and subsequent bear market. While historical analysis offers an interesting snapshot, it’s important to remember that each election year brings its own unique characteristics. Currently, the economic outlook for 2012 holds a tremendous amount of uncertainty with many factors up in the air ranging from corporate earnings to unemployment. In addition, the European debt crisis continues to weigh on global markets and the effects will remain unknown while problems go unresolved. All of these factors can potentially have a bigger impact on the market and your portfolio than the presidential election itself.
Politics and your portfolio
The political environment and upcoming election can certainly influence the stock market, as ultimately, the president plays a crucial role in directing the nation’s economic policy, tax rates, budgets, etc. But making any financial decisions based on election year market cycles is not a prudent investment strategy.
Stick with your long-term asset allocation strategy. Don’t let an election year influence your financial decision-making or your investment goals.
Copyright © Columbia Management
Tags: Bear Market, Columbia Management, Corporate Earnings, Debt Crisis, Dow Jones, Dow Jones Indexes, Dow Jones Industrial, Dow Jones Industrial Average, Economic Outlook, Election Season, Election Year, Historical Returns, Incumbent Party, Market Cycles, Market Index, Political Environment, Political Landscape, Predictable Patterns, Stock Market Performance, Upcoming Election
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Tuesday, April 10th, 2012
by Dr. Scott Brown, Ph. D, Chief Economist, Raymond James
April 9 – April 13, 2012
The stock market has risen nicely this year, partly on improving economic data, but are such gains justified by the earnings outlook? The level of the S&P 500 Index does not appear to be out of line with earnings expectations, but there may be some pressure on profits over the longer term. As the election approaches, we may hear more about class warfare.
In the late 1990s, share prices rose more than was justified by the earnings outlook. In hindsight, the market was clearly in a bubble. In the last decade, the market rose roughly in line with earnings. However, the Great Recession sent earnings sharply lower, and the stock market followed. Since the recession has ended, earnings have more than recovered. Bottom-up earnings estimates for more than a year out, compiled from analysts’ forecasts of individual companies, still look a bit giddy, but that’s typical. Top-down estimates, provided by economists and strategists, are more moderate – and consistent with some slowing in corporate earnings relative to the last few years. That’s to be expected. Much of the rebound in earnings has reflected the bounce-back from the recession. Firms have a tendency to cut too many jobs and overly curtail capital expenditures near the end of the downturn and there’s some catch-up as conditions begin to improve.
Part of the strength in corporate profits in the recovery has been due to the restraint in labor costs. Given the large amount of slack in the labor market, wage pressures are relatively subdued. Moreover, since the labor market slack is expected to remain elevated for some time, corporate profits are likely to stay relatively strong. As a percentage of national income, corporate profits are very high and labor compensation is relatively low. The share of national income going to profits and the share going to labor cycles back and forth over time and at some point the pendulum seems likely to swing back in the other direction, but probably not anytime soon.
It’s hard to have an intelligent discussion about the distribution of income. One side sites “corporate greed,” the other sites “class envy.” For the most part, economists have generally shied away from income distribution issues. This is mostly a question of politics. It’s difficult to say what an “appropriate” distribution of income should be and what steps should be taken to achieve it.
However, there’s no doubting that the distribution of income has widened significantly over the last thirty years. Real wages have stagnated. A lot of that is due to the decline of union membership. In the early 1970s, 25% of private-sector jobs were union jobs. Now unions account for less than less than 7% (note that 37% of public-sector jobs are union, but many of these are teachers and the dynamics are a lot different). In the late 1960s and early 1970s, we typically had more than 300 work stoppages per year, involving millions of workers. We had 19 last year, involving 113,000 workers.
It’s unclear what role the distribution of income will take in this year’s election, but investors should pay attention.
Tags: Capital Expenditures, Chief Economist, Class Warfare, Corporate Earnings, Corporate Profits, Downturn, Dr Scott, Earnings Estimates, Economic Data, Hindsight, Individual Companies, Labor Compensation, Last Decade, Raymond James, Recession, Share Prices, Slack, Stock Market, Strategists, Wage Pressures
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Tuesday, April 10th, 2012
by Douglas Coté, ING Investment
We just wrapped up the best first quarter since 1998, volatility has dropped to almost boring levels, fundamentals are relentlessly marching forward and global risks appear to have returned to a morenormal state.
To the astonishment of the bears, volatility, inflation and global risk are down while profits, employment and manufacturing are up — and markets have been gaining momentum with an aura of sustainability. Could it be that the vicious cycle of the past few years has been broken? Could we have entered into the type of virtuous cycle in which positive data beget more positive data, as has marked prior sustained bull markets?
“Sell in May and go away” and other bear strategies that have worked in prior years will likely be ineffective this year, driven in large part by strong fundamentals and global risks that have been excessively discounted.
Fundamentals Remain the Key to Market Success
Our “ABCDs” of fundamentals are the primary drivers of markets but have been slow to capture investor attention. This oversight has created an investment opportunity given the compelling strength in all of these drivers.
Advancing corporate profits. Fourth quarter earnings season started with a few significant misses and a lot of handwringing in the media before momentum ultimately picked up, driving double-digit year-overyear earnings growth. Sales growth was not too shabby either, with top-line revenue growth of 8.3%. The media may lament the deceleration of earnings growth, but we are, after all, continually setting the bar higher — corporate earnings reached an all-time high in 2011, and we expect a new record in 2012.
Broadening manufacturing. U.S. manufacturing has reemerged as a powerhouse, with the ISM manufacturing index expanding for 31 consecutive months. Who says “made in the U.S.A.” is fairytale of yore? Despite the rise of China and other emerging economies, the U.S. still contributes 20% to the world’s manufacturing pie; if the U.S. manufacturing sector was a country, it would be larger than Canada, India or Russia. The emerging countries have been playing catch-up, but as their wage levels increase and their productivity levels tail off, their advantage markedly decreases. Couple that with the fact that the U.S. is number one in productivity, and we say “game on”.
Manufacturing powers the entire economy
— the Bureau of Economic Analysis calculates that every $1 of manufacturing GDP drives an incremental $1.42 of economic activity in nonmanufacturing sectors.
Consumer strength underestimated. A variety of data points suggest the consumer is emerging as a game-changer. The unemployment rate, at 8.3%, is at its lowest level in three years, and the leading employment indicator, initial unemployment claims, are at 2008 lows. While high gas prices may take a bite out of consumer paychecks, it is more important that consumers are actually receiving paychecks. Personal income and personal consumption expenditures have reached all-time highs. February retail sales again surpassed the $400 billion mark to reach the highest monthly level ever. Even housing has shown signs of life, with the best January/February in five years.
Developing economies are driving global growth. Emerging markets continue to be a key catalyst for U.S. corporate revenue. With signs of a potential hard landing in China, there are concerns that weakness in this important corporate growth catalyst may put the bull market in jeopardy. No way — any slowing in China and other emerging markets will be picked up by the “frontier” or newly emerging markets. Indonesia is a good example. Indonesia, the fourth most populous country in the world, recently made headlines when its sovereign debt was upgraded to investment grade. But other good news abounds for the archipelago.
Indonesia is the largest economy in Southeast Asia and grew by 6.5% in 2011, the fastest pace in 15 years. Although 60% of their GDP is fueled by emerging middle-class consumers, Indonesia is also basking in the light of global trade as a large exporter of oil, natural gas, coal and palm oil, and it is home to the second-largest copper mine in the world.
Global Risks Continue to Wane
Europe’s PIIGS (Portugal, Ireland, Italy, Greece and Spain) remain in the news — the latest speculation is that Spain will need bailout funds to effectively recapitalize its banks. We agree. Spain is no Greece, however, and has taken strong austerity measures to contain its crisis. Spanish Prime Minister Mariano Rajoy recently announced €27 billion in budget cuts in a bid to convince the troika of the European Commission, European Central Bank and International Monetary Fund that Spain has its house in order. Alas, these troubled European countries have tended to underestimate their problems, while the market tends to overestimate their impact on the global economy with excessive worry.
The worry is unjustified. The effective fence around the European debt crisis was further bolstered at the end of March with a €700 billion boost to the permanent €500 billion European Stability Mechanism (ESM). This latest round of funding, while maybe not as ambitious as some would have liked, proves that European leaders are willing to do whatever it takes to stem the tide of contagion. Additionally, as the firewall around Europe gets stronger, it opens the door for the IMF to step in, as other countries have pledged to help contain the crisis if Europe takes those first concrete steps.
Why a Market Rally Is a Risk
There is a bigger risk looming on the horizon, bigger than all of the global and geopolitical risks omnipresent in the media. The biggest risk facing investors is a sustained, pronounced U.S. market rally — while they continue to watch from the sidelines. As equity markets move higher month after month, there remains a cadre of wouldbe investors sidelined by lingering fears of an event — i.e., the 2008 Credit Crisis — that has been over for three full years.
We get it: The credit crisis was the worst market disaster since the Great Depression. But since March 2009, the market’s postcrisis bottom, investors have missed out on double-digit equity and fixed income returns; in fact, the S&P 500 has returned almost 100% since March 2009. Many investors have downgraded themselves to “savers” by cowering in cash — $7.5 trillion to be exact
— as they wait for the dust to settle, missing a golden opportunity to build wealth.
We believe the next phase of the market rally will be driven by savers that are compelled to “capitulate” (or “throw in the towel”) and get back into the market due to a fear of being left behind. This fear is warranted; the S&P 500 is trading at a very compelling priceto- earnings ratio (P/E) of only 13.5, relative to its historical average of 15.0. An expansion of the P/E multiple to the historical average would send the S&P 500 to an all-time record high of 1575 at our earnings target of $105 per share. Compare this to a Treasury bond, which at a yield of 2% is selling at the equivalent of a 46 P/E ratio.
Historically cheap valuations are icing on the cake. Global risks are always looming, but we believe investors need to put fear aside, grab a red cape and jump into the ring with this raging bull.
This commentary has been prepared by ING Investment Management for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Any opinions expressed herein reflect our judgment and are subject to change. Certain of the statements contained herein are statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan defaults (5) changes in laws and regulations and (6) changes in the policies of governments and/or regulatory authorities.
The opinions, views and information expressed in this commentary regarding holdings are subject to change without notice. The information provided regarding holdings is not a recommendation to buy or sell any security. Fund holdings are fluid and are subject to daily change based on market conditions and other factors.
Past performance is no guarantee of future results.
©2012 ING – 230 Park Avenue, New York, NY 10169
Tags: Abcds, Bull Markets, Corporate Earnings, Corporate Profits, Deceleration, Earnings Growth, Earnings Season, Emerging Economies, Fourth Quarter Earnings, Gaining Momentum, Global Risk, Global Risks, Ing Investment, Investment Opportunity, Investor Attention, Ism Manufacturing Index, Market Success, Rise Of China, Vicious Cycle, Virtuous Cycle
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Tuesday, April 10th, 2012
There is no free-lunch – especially if that lunch is liquidity-fueled – is how Gluskin-Sheff’s David Rosenberg reminds us of the reality facing US markets this year and next. As (former Fed governor) Kevin Warsh noted in the WSJ “The ‘fiscal cliff’ in early 2013 – when government stimulus spending and tax relief are set to fall – is not misfortune. It is the inevitable result of policies that kick the can down the road.” Between the jobs data and three months in a row of declining ISM orders/inventories it seems the key manufacturing sector of support for the economy may be quaking and add to that the deleveraging that is now recurring (consumer credit) and Rosenberg sees six rather sizable stumbling-blocks facing markets as we move forward.
CHALLENGES FOR THE MARKET
First, there is liquidity — this major catalyst for equities since last October looks set to subside with the Fed seemingly backing off from a QE expansion, at least over the near-term. And the ECB is back talking about inflation so it doesn’t even look like a rate cut is coming despite escalating recession pressures in Europe. It is now also highly doubtful that China will re-open the monetary taps following the disappointing March inflation data. The liquid lunch looks less likely.
Second, there is the U.S. economy — not just the disappointing jobs data on Friday but the reality that 70% of the releases in the past month have come in below expectations. While the chain stores did report what seemed on the surface to be a solid +3.9% YoY sales gain in March, keep in mind that yet again we had very mild weather and we also had an early Easter effect.
Third, there is the rapid slowing in corporate earnings (Alcoa kicks off the reporting season tomorrow). In Q4, we had the YoY trend in S&P 500 operating earnings slip into single-digits (+9.2%) for the first time in two years, and absent Apple, the pace would have been 6.2% (see the front page of the Investor’s Business Daily). Only 62% of companies beat their estimates, which is far below average. As for Q1, the consensus is all the way down to +3.2% on a YoY basis — well off the +5.5% expectation at the turn of the year and the +12.8% forecast in the mid-part of 2011. Strip Apple out of the numbers, and you are talking about earnings growth of practically nothing— +1.8%.
Not only has earnings growth basically evaporated, but the ratio of negative to positive guidance has risen to levels we last saw two years ago, margins are poised to shrink to a two-year low as well, and only three S&P 500 sectors are actually seen raising their earnings from year-ago levels. Now the question is whether or not the market can move up with earnings contracting and the answer is — of course! We have seen that in the past, as rare as it may be. Just go back to 1998, when the Asian meltdown and strong U.S. dollar severely pinched U.S. corporate earnings, yet the S&P 500 rallied more than 20% that year. But what else happened? Well, we had the Fed cut rates three times as a super-strong antidote, and did so at a time when there was no evident slack in the labor market. Plus, we were in the early stages of an internet-led productivity spree, which underpinned profit margins. In addition, we had a Democratic president working with Congress to pass legislation that reduced red tape, labour rigidities and taxation — with no budget deficit! Please, tell me if we currently have these as antidotes for a weakening trend in corporate profits.
Fourth, there is Europe making the headlines again, and not in a positive way. Spain is back on the radar screen with a very bad bond auction last week serving up as a referendum on the government’s fiscal plan — sending the 10- year yield back up close to 6%.
We have the two rounds of French elections looming (April 22nd and May 6th) and the new government is going to have precious little time or margin of error with regard to delivering a fiscal package that will pass the ‘sniff test’ for Mr. Market. It is very clear that, in Italy, Mario Monti’s honeymoon period is over as he vacillates over parts of his economic reform package. Financial stress is highlighted by the poor performance of the euro area banks (the group that got the cyclical bounce going last November) as the group sagged 4.3% last week and is now trading near three-month lows.
On the macro front, Germany had been an economic lynchpin but no longer with industrial production sliding 1.3% in February and a downward revision to January. U.K. factory output also fell 1% — a big shock to a consensus looking for a 0.1% gain. Not just Europe, but the global economy in general is cooling off. The HSBC diffusion survey of China’s service sector slipped to 53.3 in March from 53.9 in February. Russia’s economy ministry just shaved its 2012 growth forecast to 3.4% from 3.7%.
Fifth, there is the poor technical picture. The large number of distribution days of late. The number of stocks making fresh 52-week highs is on the decline. At last week’s highs in the major averages, divergences were popping up everywhere. One particular glaring anomaly was the surge in global equities in Q1 and the sharp rise in government bond yields at a time when the CRB index faltered — if the first two asset classes were actually prescient in the view of global reflation, wouldn’t it have shown up in basic material prices given their inherent cyclical sensitivities?
Sixth, valuation support is less of a positive than it was six months ago. The cyclically-adjusted P/E at 22x for the S&P 500 is nearly 40% higher than the long-run average of 16x. The forward P/E ratio at over 13x now is about in line with the historical norm. Some nifty analysis cited on page B6 of the weekend WSJ (Why Stocks Look Too Pricey) found that when real rates are negative, as they are today, they tend to represent periods of economic turmoil and as such, the typical P/E multiple during these times is 11x — versus today’s trailing multiple of 14x. On this basis, the market as a whole (keeping in mind that we don’t buy the market, just the slices of it that we strongly believe are undervalued) is overpriced by more than 20%.
Tags: Alcoa, Corporate Earnings, David Rosenberg, ECB, Fed Governor, Gluskin Sheff, Inevitable Result, Inflation Data, Kevin Warsh, Liquid Lunch, Manufacturing Sector, Mild Weather, Qe, Reporting Season, Roadblocks, S David, Season Tomorrow, Solid 3, There Is No Free Lunch, Wsj
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