Industry analysts who cover the S&P 1500 either didn’t receive or didn’t read the European recession memo. European economies are heading down, according to November’s purchasing managers indexes (PMIs) for the euro zone and the UK. Emerging economies--including Brazil and China--are showing some signs of stress too, which most likely reflect their weakening exports to Europe, as well as the depressing impact of previous tightening of their monetary policies.
Yet, in the US, forward earnings managed to rise to new record highs for the S&P 400 MidCaps and the S&P 600 SmallCaps during the week of December 2. The forward earnings of the S&P 500 remains in a record high flat trend, which started earlier this year. It is up for the fifth straight week to $107.18, the highest reading in eight weeks.
The V-shaped recovery that started in early 2009 for the forward earnings of all three market cap indexes may be over for the LargeCaps, but it seems to be resuming now after stalling earlier this year. This may be happening because LargeCaps tend to be more exposed to sales within Europe and exports to the region than smaller US companies, which are more highly leveraged to growth in the US.
Industry analysts are clearly giving more weight to signs of resilience in the US economy despite the weakening outlook for the global economy, particularly in Europe. The US purchasing managers’ surveys for both manufacturing and nonmanufacturing stood out during November with readings above 50. Most other PMI readings around the world were below this make-or-break level for economic growth. While it’s hard to imagine that the US can decouple from the weakening global trend, industry analysts are relatively sanguine about this prospect, for now. That could all change quickly if Europe’s recession gets much worst and if Europe’s credit crunch depresses economic activity beyond the region as European banks cut back on their global lending.
So while the resilience of the three measures of forward earnings is impressive, I should warn you that they also took last gasps in mid-2008. Then they keeled over during the second half of that year through early 2009 as the US financial crisis intensified, causing a severe global recession.
The flattening of the S&P 500’s forward earnings poses a risk to Industrials. There is a very tight relationship between S&P 500 forward earnings and new factory orders. Profitable companies expand, while unprofitable ones do not. So it isn’t surprising that total orders have stalled over the past three months through October around $5.4 trillion, at a seasonally adjusted annual rate, along with the forward earnings of the S&P 500.
On the other hand, nondefense capital goods orders, which are volatile on a m/m basis, remain on an uptrend, though they dropped in October, led by a sharp decline in civilian aircraft orders. Shipments of nondefense capital goods rose to a new cyclical high of $862.4 billion (saar) over the three months through October, with new orders for construction equipment jumping to a new record high during the month.