Last summer, it became very clear that the
corporate earnings growth was coming to an end. And what followed was months of
volatile ups and downs in the markets.
Unfortunately, the earnings story hasn’t gotten
much better during this period. And even worse, the long-term outlook for
earnings growth seems to be deteriorating. This is all bad news considering earnings are the most important drivers of stock prices.
Corporate
profits tanked
While
the markets were closed on Good Friday, the Bureau of Economic Analysis
released data showing that corporate profits had
plunged 11.5% year-over-year during the fourth quarter of 2015. Excluding some unusual
items, the decline was still an ugly 7.6%.
Much of the drop can be blamed on the
unfavorable effects low prices on the energy sector and the strong dollar on
the export-driven manufacturing sector. However, economists warn of much
broader concerns.
“It also likely reflects the beginnings of a
profit margin squeeze driven by tighter labor markets, rising wages, and weak
productivity growth,” JPMorgan’s Jesse Edgerton said in an email.
The inflection in profit margins, which remain
at elevated levels, is an unsettling change.
"The
link between profit margins and recessions is strong," Barclays' Jonathan
Glionna said in an October note to clients. In other words, the deterioration in margins we're
witnessing has historically been an indicator of an impending economic
recession.
Edgerton estimates there is a 26% probability
that the US economy goes into recession within 12 months.
We
haven’t seen this since the financial crisis
The
story isn’t much different when you consider only the biggest publicly traded
firms. According to FactSet, earnings for the S&P 500 (^GSPC) fell 3.6% during the Q4 of 2015. And
that negative number is not a one-quarter deal.
“For Q1
2016, the estimated earnings decline is -8.7%,” FactSet’s John Butters said. “If the index
reports a decline in earnings for Q1, it will mark the first time the index has
seen four consecutive quarters of year-over-year declines in earnings since Q4
2008 through Q3 2009.”
While earnings aren’t crashing like they were during
the crisis, they nevertheless aren’t exhibiting the type of growth that stock
market investors would be excited about.
And I should note that the earnings you are
seeing here are benefiting from unusually favorable
accounting adjustments.
The
long-term story is depressing
For long-term investors, short-term gyrations
in earnings and stock prices are to be expected.
The problem, however, is that the long-term
outlook for earnings growth is uninspiring.
While it’s not never an easy task to forecast
earnings, at least consider what’s implied by the markets. One way to do this
is by first applying a premium over the return offered by the somewhat safer
bond markets.
“When one applies a constant long-term equity
risk premium of 3.0% and incorporates
both the 10-year bond yield and the dividend yield, one can calculate an
embedded long-term EPS growth trend of less than 4%, which is below the implied
levels seen since 1965, ”Citi’s Tobias Levkovich
observed in a February 12 note to clients.
It’s
worth reiterating that this long-term outlook for earnings growth is derived
from bond yields, which have been tumbling for the better part of the last
three decades. But as Moody’s John Lonski argues, low bond
yields are arguably an effect of low returns expected in riskier markets like
the stock markets, which appear to be facing the prospect of low earnings
growth.
“Expected returns from riskier assets help to
determine US Treasury bond yields,” Lonski said in a March 17 note to clients.
“All else the same, Treasury bond yields will be lower, the less is the
expected return from other assets.”
In his note, titled “Long-Term Profits Outlook
Lowest in Decades,” Lonski observed that the so-called “Blue Chip” consensus
was currently forecasting a 3.2% average annual rate of profit growth for 2016
to 2022. This was down sharply from the 5.3% rate forecasted for the same
period when the survey was conducted in March 2011.
This plays into the forecasts of money managers
like Nuveen, GMO, and Hussman Funds, who have been calling for
less-than-stellar returns in the stock market.
No comments:
Post a Comment