8/6/21: This Recession Is Different: Corporate Profits Boom

 

Corporate profits guidance is booming. Which, one might think, is a good signal of recovery. But the recession that passed (or still passing, officially) has been abnormal by historical standards, shifting expectations for the recovery to a different level of 'bizarre'.

Consider non-financial corporate profits through prior cycles: 

Chart 1 above shows non-financial corporate profits per 1 USD of official gross value added in the economy. In all past recessions, save for three, going into recession, corporate profit margins fell below pre-recession average. Three exceptions to the rule are: 1949 recession, 1981 recession and, you guessed it, the Covid19 recession. In other words, all three abnormal recessions were associated with significant rises in market power of producers over consumers. And prior abnormal recessions led to subsequent need for monetary tightening to stem inflationary pressures. Not yet the case in the most recent one.

The second chart plots increases in corporate profit margins in the recoveries relative to prior recessions. Data is through 1Q 2021, so we do not yet have an official 'recovery' quarter to plot. If we are to treat 1Q 2021 as 'recovery' first quarter, profits in this recovery are below pre-recovery recession period average by 2 percentage points. Again, the case of two other recessions compares: the post-1949 recession recovery and post-1980s recovery are both associated with negative reaction of profits to economic cycle shift from recession to recovery.

Which means two things:

1. Market power of producers is rising from the end of 2019 through today, if we assume that 1Q 2021 was not, yet, a recovery quarter (officially, this is the case, as NBER still times 1Q 2021 as part of the recession); and
2. Non-financial corporate profits boom we are seeing reported to-date for 2Q 2021 is a sign not of a healthier economy, but of the first point made above.

In effect, some evidence that Covid19 pandemic was a transfer of wealth from people to companies that managed to trade through the crisis. 

3/5/21: Margin Debt: Things are FOMOing up...

 Debt, debt and more FOMO...

Source: topdowncharts.com and my annotations

Ratio of leveraged longs to shorts is at around 3.5, which is 2014-2019 average of around 2.2. Bad news (common signal of upcoming correction or sell-off). Basically, we are witnessing a FOMO-fueled chase of every-rising hype and risk appetite. Meanwhile, margin debt is up 70% y/y in March 2021, although from low base back in March 2020, now back to levels of growth comparable only to pre-dot.com crash in 1999-2000. Adjusting for market cap - some say this is advisable, though I can't see why moderating one boom-craze indicator with another boom-craze indicator is any better - things are more moderate. 

My read-out: we are seeing margin debt acceleration that is now outpacing the S&P500 acceleration, even with all the rosy earnings projections being factored in. This isn't 'fundamentals'. It is behavioral. And as such, it is a dry powder keg sitting right next to a campfire. 

17/9/20: Stonks are Getting Balmier than in the Dot.Com Heat

Via Liz Ann Sonders @LizAnnSonders of Charles Schwab & Co., Inc. a neat chart summarizing the madness of the King Market these days:

Yeah, right: PE ratio is heading for dot.com madness levels, PEG ratio (price earnings to growth ratio or growth-adjusted PE ratio) is now vastly above the dot.com era peak, and EPS is closer to the Global Financial Crisis era lows. 

What can possibly go wrong, Robinhooders, when a mafia don gifts you some chips to wager at his casino?

24/7/20: Bonds v Stocks: Of Yields, Investors and Large Predators

Corporates are reeling from the COVID19 pandemic impacts, yet stocks are severely overpriced by all possible corporate finance metrics. Until, that is, one looks at bonds.

Over the 3 months through June 2020, average 10 year U.S. Treasury yield has been 0.69 percent. Over the same period, average S&P500 dividend yield was 2.02 percent. The gap between the two is 1.33 percentage points, which (with exception of March-May average gap of 1.42 points) is the highest in history of the series (from 1962 on).

Given that today's Treasuries are carrying higher liquidity risk (declining demand outside the official / Fed demand channel) and higher roll-over risks (opportunity cost of buying Ts today compared to the future), the real (relative) bubble in financial markets todays is in fixed income. Of course, in absolute returns terms, long-term investment in either bonds or equities today is equivalent to a choice of being maimed by a T-Rex or being mangled by a grizzly. Take your pick.

21/7/20: Stonks and Stinks: S&P500 Net Profit Margins

Stonks reporting season is rolling on. And so far, things are predictably gloomy:

Yeeks! But wait, by sector:

• Seven out of eight sectors are reporting lower net profit margins than 5 year average, with Utilities being the only sector reporting above average margins;
• Nine out of nine sectors reported so far have lower net profit margins than in 2Q 2019.

Per Factset: "For the second quarter, the S&P 500 is reporting a year-over-year decline in earnings of -44.0% and a year-over-year decline in revenues of -10.5%."

Double yeeeks!

Meanwhile, what's S&P and stonks are doing? 1 month chart:

and 3 months

Because happiness is just around the corner for all.

6/5/20: S&P500 and Fundamentals: What should matter, doesn't

S&P500 and earnings per share: what should matter, doesn't

We are now in extreme territory of the markets ignoring basic corporate fundamentals.

6/5/20: S&P500 Earnings and Revenues Growth 1Q 2020

With early effects of COVID19 pandemic in:

Both charts via Factset.

8/2/20: Price-to-Sales Ratio Hits an All-Time High for S&P500

Stock are not overvalued, folks. Because, you know, stocks valuations are no longer making any sense...

Via @HondoTomasz, comes this nice chart, plotting the 18-year high in S&P500 PE ratios (gamable) and the all-time highs in Price-to-Sales ratio (less gamable). Do remember, folks, sales are a positive function of inflation and inflation has been pretty weak, of late. Which means that sales are facing two headwinds at the same time: low inflation pressures and low demand growth pressures. Yet, share prices are just keep climbing up in this new economic paradigm that looks like the old Dot.Com paradigm.

15/1/20: S&P500 Historical Performance

Via BAML and @tracyalloway, a chart plotting the distribution of annual returns on S&P500, 1872-2019:

The stylised nature of this plot allows us to see the right-skew in the distribution, across all 

'bins', especially for the last decade.

6/9/19: Small Cap Stocks EPS: racing to the bottom of the MAGA barrel

Everything is going just plain swimmingly in the Land of MAGA, where American companies are now expected to do their duty by President Trump's agenda for investment in the U.S. because, you know, this:

As 'share' part of the EPS ratio has shrunk (thanks to buybacks and M&As tsunami of recent vintage), earnings per share should have gone up... and up... and up. Instead, small cap stocks' EPS has collapsed. To the lowest levels since the 2007-2008 crisis.

But never mind, more money printing by the Fed will surely cure it all.

Source for the above chart: @soberlook and WSJ.

31/7/19: Fed rate cut won't move the needle on 'Losing Globally' Trade Wars impacts

Dear investors, welcome to the Trump Trade Wars, where 'winning bigly' is really about 'losing globally':

As the chart above, via FactSet, indicates, companies in the S&P500 with global trading exposures are carrying the hefty cost of the Trump wars. In 2Q 2019, expected earnings for those S&P500 firms with more than 50% revenues exposure to global (ex-US markets) are expected to fall a massive 13.6 percent. Revenue declines for these companies are forecast at 2.4%.

This is hardly surprising. U.S. companies trading abroad are facing the following headwinds:

1. Trump tariffs on inputs into production are resulting in slower deflation in imports costs by the U.S. producers than for other economies (as indicated by this evidence: https://trueeconomics.blogspot.com/2019/07/22719-what-import-price-indices-do-not.html).
2. At the same time, countries' retaliatory measures against the U.S. exporters are hurting U.S. exports (U.S. exports are down 2.7 percent in June).
3. U.S. dollar is up against major currencies, further reducing exporters' room for price adjustments.

Three sectors are driving S&P500 earnings and revenues divergence for globally-trading companies:

• Industrials,
• Information Technology,
• Materials, and 
• Energy.

What is harder to price in, yet is probably material to these trends, is the adverse reputational / demand effects of the Trump Administration policies on the ability of American companies to market their goods and services abroad. The Fed rate cut today is a bit of plaster on the gaping wound inflicted onto U.S. internationally exporting companies by the Trump Trade Wars. If the likes of ECB, BoJ and PBOC counter this move with their own easing of monetary conditions, the trend toward continued concentration of the U.S. corporate earnings and revenues in the U.S. domestic markets will persist. 

7/7/19: Investment for growth is at record lows for S&P500

Interesting chart via @DavidSchawel showing changes over time in corporate (S&P500 companies) distribution of earnings:

In simple terms:

1. Much discussed shares buybacks are still the rage: running at 31% of all cash distributions, second highest level after 34% in 2007. On a cumulated basis, and taking into the account already reduced free float in S&P 500 over the years, this is a massive level of buybacks.
2. 'Investment for growth' - as defined - is at 51% - the lowest on record.
3. Meaningful investment for growth (often opportunistic M&As) is at 38%, tied for the lowest with 2007 figure.

S&P 500 firms are clearly not in investment mode. Despite 'Trump incentives' - under the TCJA 2017 tax cuts act - actual capex is running tied to the second lowest levels for 2018 and 2019, at 26% of all cash distributions.

14/6/19: Rising Concentration Risk in S&P500 Earnings and Revenues

S&P 500 companies earnings and revenues are heading for another round of de-diversification (increasing concentration of earnings and revenues toward the U.S. markets), per Factset latest data:

14/5/19: Trump's Trade Wars and Global Growth Slowdown Put Pressure on Corporate Earnings

The combined impacts of rising dollar strength, reduced growth momentum in the global economy and President Trump's trade wars are driving down earnings growth across S&P500 companies with double-digit drop in earnings of companies with more global (>50% of sales outside the U.S.) as opposed to domestic (<50 exposures.="" of="" p="" sales="" the="" u.s.="" within="">
Per Factset data, released May 13, "The blended (combines actual results for companies that have reported and estimated results for companies yet to report) earnings decline for the S&P 500 for Q1 2019 is -0.5%. For companies that generate more than 50% of sales inside the U.S., the blended earnings growth rate is 6.2%. For companies that generate less than 50% of sales inside the U.S., the blended earnings decline is -12.8%."

12/3/19: S&P500 Concentration Risk over 10 years

More on increasing concentration risks in the U.S. equity markets: Goldman Sachs estimates that almost 1/4 of total return to S&P500 over the last 10 years came from just 10 stocks:

Of these, Apple alone accounted for almost 1/5th of total return to S&P500. 22% of total return was accounted for by ICT sector.

6/3/19: Expectations Sand Castles and Investors

As raging buybacks of shares and M&As have dropped the free float available in the markets over the recent years, Earnings per Share (EPS) continued to tank. Yet, S&P 500 valuations kept climbing:

Source: Factset 

As noted by the Factset: 1Q 2019 "marked the largest percentage decline in the bottom-up EPS estimate over the first two months of a quarter since Q1 2016 (-8.4%). At the sector level, all 11 sectors recorded a decline in their bottom-up EPS estimate during the first two months of the quarter... Overall, nine sectors recorded a larger decrease in their bottom-up EPS estimate relative to their five-year average, eight sectors recorded a larger decrease in their bottom-up EPS estimate relative to their 10-year average, and seven sectors recorded a larger decrease in their bottom-up EPS estimate relative to their 15-year average."

Bad stuff. Yet, "as the bottom-up EPS estimate for the index declined during the first two months of the quarter, the value of the S&P 500 increased during this same period. From December 31 through February 28, the value of the index increased by 11.1% (to 2784.49 from 2506.85). The first quarter marked the 15th time in the past 20 quarters in which the bottom-up EPS estimate decreased while the value of the index increased during the first two months of the quarter."

The disconnect between investors' valuations and risk pricing, and the reality of tangible estimations for current conditions is getting progressively worse. The markets remain a spring, loaded with the deadweight of expectations sand castles.

8/12/18: Shares Buybacks Hit Diminishing Marginal Returns

The S&P 500 Buyback Index Total Return data tracks the performance of the top 100 stocks with the highest buyback ratios in the S&P 500 in terms of total return. As the chart below shows, the Buyback Index has generally and significantly outperformed S&P500 returns since 2008:

with three discernible periods of outperformance highlighted in the second chart:

In simple terms, since December 2015, the Buyback Index Total Return performance relative to S&P500 returns has stagnated, despite accelerating buybacks by the S&P500 corporates. In part, this is driven by the increased buybacks activity in the less active companies (not constituents of the Buyback Index), but in part the data suggests that the returns to buybacks are generally tapering out.

At the same time, correlation between S&P500 returns and Buyback Index returns has been weakening from around the same time:

All of the above indicates a breakdown in the traditional post-2008 pattern of returns, as buybacks role as the drivers for improved ROE performance for top S&P500 shares re-purchasers is starting to run into diminishing returns.

15/5/18: S&P500 Earnings Diversification: International Trading Pays

An intersting (and occasionally covered on this blog) chart via FactSet on earnings and revenue growth for S&P500 constituents based on their exposures to international markets:

As the above clearly shows, globally diversified (by source of activity) companies have stronger growth in earnings and aggregate earnings. Not surprising, in general, but given the relative strength of the U.S. growth, compared to other regions' dynamics, this shows the value of income diversification.

19/4/18: Geopolitical Risk: Who Cares?..

Geo-political risks, geo-shmalitical risks... who cares... not the markets...

None of the geopolitical risks registered on S&P 500 companies reporting radar according to Factset in 1Q 2018 https://insight.factset.com/more-than-half-of-sp-500-companies-citing-positive-impact-from-fx-on-q1-earnings-calls.  This is not very surprising as majority of earnings for 1Q accumulated before any spikes in these, and as "Tariffs" category probably absorbed the 'China' effect. Notably, however, earnings were impacted adversely by trade conflict and cyber risks (total of 3/25 companies impacted).

19/3/18: Bitcoin as a Hedge?..

The story of Bitcoin has been told, repeatedly, as a story of an asset that offers a hedge to stocks, a hedge against the fiat currencies and a hedge against the excesses of QE. That story is pure, unadulterated bullshit.

As the chart above shows, Bitcoin is more of a lead-indicator to S&P 500, than a hedge. With volatility well in excess of other comparable instruments.