Another Weak Revenues Season (excerpt)

According to Standard & Poor's, S&P 500 revenues fell 2.3% y/y during Q1 mostly as a result of the plunge in the revenues of the Energy Sector, and also the strength of the dollar. On a same company basis for both periods, we calculate that S&P 500 revenues fell 3.0% y/y during Q1, but rose 2.4% excluding the Energy sector.  A similar pattern is likely for Q2. Industry analysts currently estimate a 4.0% decline in revenues during the quarter, but a small gain of 1.5% excluding Energy.

The y/y growth rate in S&P 500 revenues tends to be highly correlated with the comparable growth rate in manufacturing and trade sales. The latter was down 2.2% in May, but up 1.9% excluding petroleum.

Industry analysts are currently estimating the following revenues growth rates for Q2 on a y/y basis, from high to low: Health Care (6.1%), Telecommunication Services (2.8), Information Technology (2.6), Financials (2.5), Consumer Staples (2.4), Consumer Discretionary (2.0), Utilities (0.0), Industrials (-3.9), S&P 500 (-4.0), Materials (-8.8), and Energy (-34.8).

Today's Morning Briefing: United Shoppers of America (USA!) (1) USA women rule soccer! (2) A patriotic happening. (3) Crowd chants “USA! USA! USA!” (4) Soccer unites, politics divides. (5) The standard of living and income inequality debate. (6) Flawed income measures used to gauge inequality and poverty. (7) Key items missing. (8) What about the Earned Income Tax Credit? (9) What about government support programs? (10) Real consumer spending per household at record high. (11) Consumer stocks confirm strength of consumer. (12) Another weak earnings season for revenues, led by plunge in Energy. (13) The Greek deal is to make a deal. (14) Tsipras as Sisyphus. (15) Focus on market-weight-rated S&P 500 Retail industries. (More for subscribers.)

Here Comes Another Earnings Season (excerpt)

S&P 500 earnings rose 1.4% y/y during Q1. That’s not much, but industry analysts expected a drop of 4.0% at the start of that quarter’s earnings season. Among the sectors, the big loser was Energy. Excluding it, earnings rose impressively by 11.2% y/y. Here is the rundown of Q1’s earnings performance derby from best to worst: Financials (19.6%), Health Care (19.4), Information Technology (10.3), Consumer Discretionary (8.1), Industrials (5.5), Consumer Staples (4.0), Utilities (2.4), Materials (2.0), Telecommunication Services (1.8), and Energy (-59.7).

Q2 might also show underlying strength. Industry analysts are currently estimating that S&P 500 earnings will be down 4.5% y/y during the quarter. The latest analysts’ earnings consensus performance derby for the sectors is as follows: Financials (14.7%), Consumer Discretionary (7.1), Telecom (5.6), Health Care (4.1), Tech (3.0), Materials (1.2), Utilities (0.9), Industrials (-0.3), Consumer Staples (-2.9), and Energy (-63.8). Excluding Energy, the consensus currently anticipates a 4.8% gain in Q2 results.

Given that the price of oil crashed during the second half of last year, Energy earnings may continue to weigh on aggregate earnings during Q3, but have a diminishing impact from Q4 into next year. That’s assuming the price of oil won’t be dropping again anytime soon, as I do. That might be a bad assumption if the sanctions on Iran’s oil exports are lifted. I am also assuming that the trade-weighted dollar isn’t going much higher. That might be a bad assumption if Greece exits the Eurozone, which I am not expecting.

Today's Morning Briefing: Zigzag. (1) Another earnings season is around the corner. (2) Why do industry analysts cut their estimates? (3) We count 58 “earnings hooks” over the past 85 quarters. (4) The longest streak is the current one. (5) Will Q2 be as surprisingly strong as Q1, excluding Energy? (6) Joe slices and dices earnings. (7) With P/Es stretched, earnings matter more. (8) Health Care leads the pack. (9) US consumer indicators are mostly upbeat, while business indicators are mixed. (10) Focus on market-weight-rated S&P 500 housing-related industries. (More for subscribers.)

Varieties of Valuation (excerpt)

In my ongoing research on valuation, I constructed a quarterly P/E series for the S&P 500 based on reported earnings from Q4-1935 through Q3-1988, and operating earnings since then. Its average is exactly 15.0. It was 18.5 during Q1-2015. It has been this high before and sometimes gone higher. A reversion-to-the-mean valuation model is bearish based on this measure of the P/E since it is currently higher than its mean.

Over 30 years ago, Jim Moltz, my mentor at CJ Lawrence during the 1990s, devised the Rule of 20. It states that for equities to be fairly valued, the P/E ratio plus the inflation rate has to be around 20. In April, the CPI inflation rate was minus 0.2% y/y, implying that the fair-value P/E should be 20.2, well above the trailing P/E. On the other hand, the core CPI was up 1.8% y/y, suggesting that 18.2 is the right valuation number.

Greg Donaldson, the chief investment officer of Donaldson Capital Management and a subscriber and friend of Yardeni Research, offers an interesting inflation-based analysis of the P/E in a 5/16 Seeking Alpha article titled “The Great P/E Debate: Are Stocks Overvalued?” Greg writes: “We do not find strong relationships between any of the widely followed indicators such as interest rates, GDP growth or earnings growth. We have found that inflation is the best predictor of P/E ratios at any given point in time.” He ran a regression of inflation (using the core PCED) on the earnings yield (E/P). He used it to calculate that the current P/E should be about 21 based on his model.

In addition to tracking the trailing P/E, I also monitor market-capitalization-to-sales and price-to-sales ratios. During Q1, the Fed’s Financial Accounts showed that the ratio of the market capitalization of all equities traded in the US (excluding foreign issues) to nominal GDP rose to 1.69, the highest since Q3-2000. The comparable ratio for the S&P 500 rose to 1.87 during Q1, also the highest since Q3-2000. The ratio of the S&P 500 to its forward revenues per share rose to a cyclical high of 1.82 in early June. Stocks are seriously overvalued according to these measures.

Today's Morning Briefing: Slice & Dice. (1) The valuation question again. (2) Waiting for the answer while stocks meander. (3) Earnings-led target of 2300 for the S&P 500 next year. (4) Reversion-to-the-mean model is bearish. (5) A 20 P/E isn’t irrational according to inflation models. (6) Fed model says either stocks are too cheap or bonds are too expensive. (7) Does revenues growth matter to valuation? (8) Price-to-sales models are bearish. (9) Retail sales data suggest soft patch is over. (10) Our in-house Gen Xer slices and dices generational demographics from A to Z. (11) “Love & Mercy” (+ + +). (More for subscribers.)

No Soft Patch for Small Business (excerpt)

The NFIB survey of small firms reports a series reflecting the net percentage of business owners saying that their earnings were higher over the past three months versus lower. It has been negative since the start of the data in January 1986. It jumped last month to -7%, the highest reading since October 2005. It’s up from the series’ record low of -47% during January 2009.

Not surprisingly, the 12-month average of the earnings series is highly correlated with the NFIB small business optimism index. When small business owners are optimistic because their earnings are improving, they tend to hire workers. Sure enough, the percentage of small companies expecting to increase employment is up to 11.6%, the highest since February 2008. The percentage of small firms with job openings is up to 25.4%, the highest since December 2001.

The latest NFIB survey noted: “Owners report that the labor market is, from an historical perspective, getting very tight. Owner complaints about ‘finding qualified workers’ are rising, job openings are near 42 year record high levels, and job creation plans remain solid. Over 80 percent of those hiring or trying to hire in May reported few nor no qualified applicants.” In an obvious dig, the report added that there’s not much the Fed can do to increase the supply of qualified workers.

Today's Morning Briefing: Small Business Is Big. (1) Jury is out on soft-patch verdict. (2) No soft patch for small business owners. (3) Businesses create jobs, not governments. (4) Small businesses lead the way. (5) Corporate profits lead employment and capital spending. (6) Hard to find qualified workers. (7) Capital spending improving, but lagging. (8) A real jolt in JOLTS. (9) SMidCaps vs. LargeCaps. (10) Falling oil prices have had bigger impact on earnings than rising dollar. (11) Margins getting squeezed among SMidCaps as they ramp up hirng. (More for subscribers.)

Trailing P/E Is On the High Side (excerpt)

As I noted recently, valuation, like beauty, is in the eye of the beholder. I think P/Es are high. Others disagree and say they can go higher given historically low inflation and interest rates.

I counter that low inflation rates are contributing to low revenues growth. Given record-high profit margins, total earnings aren’t likely to rise faster than total revenues. Low interest rates are offset by low earnings growth, in my opinion. I’ve constructed a quarterly P/E measure based on S&P 500 reported earnings from Q1-1960 through Q3-1988 and operating earnings since then when it first became available. Consider the following:

(1) Reversion to the mean. The average of this combined series is 16.2. The P/E was 18.5 during Q1, exceeding the average by 2.3 percentage points. Historically, readings of 20.0 or more have proved to be high and often followed by bear markets.

(2) Inflation and interest rates. There is a stronger inverse correlation between the CPI inflation rate and the P/E than between the 10-year Treasury bond yield and the PE. Arguably, they both justify still higher P/Es.

(3) Earnings growth. However, there is also a very good correlation between analysts’ consensus expected long-term earnings growth over the next five years for the S&P 500 and the P/E. The former suggests that the latter may be too high.

(4) Valuation and beauty. I come to the same conclusion as before: Valuation, like beauty, is in the eye of the beholder.

Today's Morning Briefing: Which Way Is the Wind Blowing? (1) Jefferson, Einstein, and Twain. (2) The weather will change. (3) Neither boom nor bust. (4) OECD paints a picture with some shades of grey. (5) China’s trade data confirm domestic weakness. (6) Eurozone on recovery road, as Greece can gets kicked down the road. (7) Japan isn’t getting much bang for all those yen. (8) Waiting for Thursday’s retail sales report. (9) Real exports are really OK. (10) Dead calm for US stocks. (11) Revenues growth outlook is neither hot nor cold. (12) Valuation vs. reversion to the mean, inflation and interest rates, and earnings growth. (More for subscribers.)

Has Profits' Share of National Income Peaked? (excerpt)

Profits’ share of national income is very volatile over the business cycle because it reflects the volatility of its two determinants that also fluctuate with the business cycle, namely revenues and the profit margin. The latter is the more volatile of the two and is highly correlated with profits’ share of national income. It has the same cyclical pattern as profits’ share of national income. They both rise rapidly during recoveries and expansions when revenues tend to rise faster than costs, which boosts the profit margin. They both tend to peak and fall near the tail end of expansions when costs, including payrolls and capital spending, start to outpace revenues. During recessions, profits plunge on an absolute and relative basis as revenues fall faster than costs, which also depresses profit margins.

The jury is still out on whether the profit margin has peaked, having risen to a record high of 10.4% during Q1 for the S&P 500. That will depend on whether companies will raise wages as they continue to expand their payrolls. It will also depend on whether the pace of capital spending picks up. So far, there’s not much evidence that these costs are taking off.

However, the profit margin can also get squeezed if revenues growth slows, which does seem to be happening. That’s because global economic growth is lackluster. Yesterday, the Organization for Economic Cooperation and Development lowered its forecast for world economic growth to 3.1% this year and 3.8% in 2016, down from its prediction six months ago of 3.6% and 3.9% growth, respectively. Furthermore, revenues growth has been hard hit by the drop in oil prices and the strength in the foreign exchange value of the dollar since last summer.

Today's Morning Briefing: What’s the Trend in Profits? (1) Why profits can’t grow faster (or slower) than GDP. (2) Profits’ share of national income may be peaking. (3) Profits are very pro-cyclical because so are revenues and profit margins. (4) Record high for S&P 500 profit margin. Can it go higher? (5) Two ways to squeeze margins: Higher costs vs. lower revenues. (6) The OECD cuts its estimate for world growth. (7) Profits cycle driving the business cycle. (8) Using the value of world exports as a proxy for global GDP. (9) Beware of false slowdown in world economic indicators measured in dollars. (10) Is 5% rather than 7% the new normal? (More for subscribers.)

The Trend in Profits (excerpt)

The growth trend of corporate profits is determined by the growth trend of nominal GDP. My analysis shows that the trend of these variables has been 7% since 1960. Profits growth is much weaker during recessions and much faster during recoveries, but 7% has been the magic number for the trend. That seems to be the best we can expect in the coming years until the next recession. Given that valuation multiples are at their historical highs, 7% may also be the best we can expect in terms of annual capital gains in the stock market for the duration of the current bull market. That’s quite good compared to the bond yield and the inflation rate, which are both historically low.

On a cyclical basis, there is a strong correlation between the y/y growth rates of nominal GDP and S&P 500 revenues in aggregate. The correlation is even better with nominal GDP for goods. The two series do diverge often on a short-term basis, but have the same cyclical pattern. During Q1, revenues fell 2.5% y/y, while nominal GDP with and without services rose 3.6%. The recent plunge in oil prices had a bigger impact on S&P 500 revenues than on nominal GDP.

Over the past four and a half years, nominal GDP has been growing just under 5%, so it’s possible that this may be the new magic number for the trend growth in GDP, and therefore in profits. While there has been some recent chatter about the depressing impact of seasonal adjustment factors on Q1 real GDP, that distortion is eliminated simply by tracking the y/y growth rate, which has been relatively stable around 2.5% since mid-2010. In fact, while real GDP fell 0.7% (saar) during Q1, it was up 2.7% y/y! Meanwhile, inflation continues to decelerate in the GDP accounts. The GDP price deflator was up just 0.9% y/y during Q1, with the core rate also low at 1.1%. Again, put these trends together, and nominal GDP is growing below 5% rather than close to 7%.

Today's Morning Briefing: Probing Profits. (1) Profits measures: Take your pick. (2) We pick forward earnings. (3) Is the 7% trend still our friend for profits growth, or might it be 5%? (4) How much longer can profit margins break records? (5) Cash flow stalled at record high. (6) The government should fill potholes. (7) Assessing the soft patch in the oil patch. (8) Regional surveys add up to weak May. (9) Frightful freight index. (10) Signs of life in Eurozone’s corporate earnings. (More for subscribers.)

Signs of a Recovery in Eurozone Profits (excerpt)

The ECB isn’t buying stocks (just yet), but the bank’s officials are certainly doing their best to boost stock prices by depressing the euro and keeping a lid on interest rates. Last Thursday, ECB President Mario Draghi countered any notion that the bank’s QE might be tapered ahead of schedule. He was clearly concerned about the recent backup in bond yields, strength in the euro, and weakness in stock prices. To make sure everyone got the message, another member of the ECB’s executive board said on Monday evening that the bank will front-load some of its purchases of sovereign debt in May and June.

The forward earnings of the EMU MSCI seems finally to be turning up as both 2015 and 2016 earnings estimates have stopped falling recently. NERI turned positive during April (1.3) and rose to a five-year high in May (4.0) following 48 consecutive months of negative readings. The upturn is widespread including Germany, France, and Spain, though not Italy so far.

The weaker euro finally might be starting to boost profits in the Eurozone. There is probably more upside for the region over the rest of the year barring a Grexit.

Today's Morning Briefing: Central Planners. (1) Does kicking the can beat the alternative? (2) Why can’t a series of short-term fixes be a long-term fix? (3) The Greek example. (4) Central bankers have turned into central planners. (5) The latest plan is to do more of the same to drive up stock prices. (6) China’s new plan is to pump up stock prices. (7) BOJ buying ETFs. (8) Profits finally showing signs of life in Eurozone. (9) US lags while FOMC plays Hamlet. (10) What do Fed economists do all day? (11) Fed staff attacks Piketty and other Progressives. Read all about it! (12) Fed debates seasonal distortions. (More for subscribers.)

Reenergized Earnings? (excerpt)

If oil prices have bottomed and the dollar has peaked, then forward earnings should be moving forward again. Until recently, the S&P 500 forward earnings was tracking 7% annualized growth, the historical trend for this series.

If so, then forward earnings is currently predicting that the four-quarter trailing average of S&P 500 earnings, which was $119.20 per share during Q1, will rise to around $125 early next year. I am forecasting $130 for all of 2016, up from $120 this year.

Of course, this optimistic outlook requires that the economy finds some traction to get out of its current soft patch with both business sales and industrial production rebounding from their recent dips and moving to new highs again.

Today's Morning Briefing: Reenergized Earnings? (1) From “peak oil” to “cheap oil” to bad oil data. (2) Will the real Phil please stand up? (3) What are oil inventories doing? (4) EIA gets authority to require oil drillers to fill out a monthly supply survey. (5) Fewer railcar loadings of oil. (6) Lots in storage still. (7) World oil demand/supply ratio remains bearish. (8) Oil earnings may have stopped weighing on S&P 500. (9) Profit margins rebounding from recent dip. (10) Brighter outlook for earnings depends on soft patch as well as oil patch. (11) Focus on market-weight-rated S&P 500 Energy industries. (More for subscribers.)

Revenues & Earnings Coming Back Down to Earth? (excerpt)

While valuation multiples are flying into the wild blue yonder, revenues and earnings have been coming back down to Earth. But that’s all because of the crash in the Energy sector. Excluding this sector, the skies are still relatively sunny. Nevertheless, investors have to beware of repeating the fate of Greek mythology’s Icarus, who flew too close to the sun, melting the wax on his homemade wings and sending him into the sea. It was the first meltdown recorded in human history. Let’s have a closer look at the data:

(1) Revenues. The y/y growth in S&P 500 revenues, as compiled by Thomson Reuters I/B/E/S, is highly correlated with the comparable growth in manufacturing and trade sales. The former was down 1.8% y/y through Q1, while the latter declined 2.4% through March. However, excluding petroleum products, business sales rose 2.4% y/y. Petroleum-related sales plunged 31.7% y/y through March.

(2) Earnings. Thomson Reuters I/B/E/S calculates that S&P 500 earnings fell 6.3% q/q to $28.58 per share during Q1. It was up just 1.4% y/y. Excluding the Energy sector, Q1 earnings rose 11.5%. The following sectors had very strong results: Health Care (19.8%), Financials (19.5), and Tech (11.2).

Today's Morning Briefing: Wild Blue Yonder. (1) David Bowie’s scenario for stocks. (2) Valuations are flying into the wild blue yonder. (3) Blue Angels and the stunt plane. (4) Icarus and Major Tom. (5) Revenues and earnings have come back to Earth, but are still flying excluding Energy. (6) Joe confirms earnings rose 11.5% y/y during Q1 excluding Energy. (7) Not much spring in consumer’s step. (8) Four theories for why consumer spending is disappointing. (More for subscribers.)

Analysts Continue to Lower S&P 500 Earnings (excerpt)

Although the dollar might have peaked on March 13 for a while, and the price of crude oil might have bottomed on January 13 for a while, industry analysts who cover the S&P 500 are still lowering their earnings estimates for both 2015 and 2016. They now expect $119.02 and $134.18 per share for this year and next year, down 5.9% and 5.2% from their estimates at the end of last year. For this year, they’ve been lowering their Q2-Q4 estimates as earnings have beaten expectations during Q1 with a 4.7% “hook-up” move so far over the past two weeks, which is typical during earnings seasons.

It’s getting harder to find much if any GAARP (growth at a reasonable price) in the US given the latest lofty valuation ranking for the S&P 500 sectors: Energy (28.8 vs. 14.2 year ago), Consumer Staples (19.7, 17.4), Consumer Discretionary (19.0, 17.4), Health Care (17.8, 16.2), Materials (17.2, 16.7), S&P 500 (17.2, 15.3), Utilities (16.4, 16.1), IT (16.2, 14.4), Industrials (16.2, 16.3), Financials (13.9, 13.5), and Telecom Services (13.4, 13.1).

Today's Morning Briefing: The World According to GAARP. (1) John Irving’s terminal cases. (2) Desperately seeking growth at a reasonable price. (3) Is looking for GAARP like waiting for Godot? (4) Global synchronized secular stagnation. (5) Industry analysts aren’t exuberant about outlook for revenues and earnings. (6) Secular stagnation rather than boom or bust. (7) Valuations aren’t cheap, but could go higher in a liquidity-driven melt-up. (8) Hard to find much GAARP in US. (9) Global M-PMIs uninspiring. (More for subscribers.)

S&P 500 Forward Earnings Driving Economic Slowdown (excerpt)

There are lots of correlations between S&P 500 forward earnings and several key economic indicators. The former dropped sharply late last year and early this year as Energy industry analysts slashed their earnings estimates for this year and next year.

While the plunge in oil prices accounts for much of the weakness in forward earnings since last fall, the soaring dollar has also weighed on earnings. Corporate profits tend to be the key driver of employment and capital spending. Profitable companies tend to expand their payrolls and capacity. Unprofitable companies don’t do so.

This explains why there is such a good correlation between the y/y growth rates of forward earnings and aggregate weekly hours. Forward earnings is also highly correlated with total factory orders as well as nondefense capital goods orders excluding aircraft. The weakness in forward earnings confirms that the slowdown in US economic growth so far this year wasn’t attributable just to the icy winter. Spring’s economic indicators remain disappointing so far.

The profits picture should brighten a bit if the dollar has peaked and oil prices have bottomed. The US economic outlook should also brighten in this scenario. However, don’t expect a boom.

Today's Morning Briefing: Forward Thinking. (1) Six degrees of separation. (2) LinkedIn and the kindness of strangers. (3) Correlations and divergences. (4) Industrial commodity prices aren’t confirming oil rally. (5) The oil price might have bottomed and peaked. (6) The dollar might have peaked. (7) Don’t buy into A$, C$, and gold rallies. (8) Expected inflation rebounding. (9) Forward earnings flagging, and so is economy. (10) Profitable companies expand. Unprofitable ones don’t. (11) Neither boom nor bust. (12) Focus on now underweight-rated S&P 500 housing-related industries. (More for subscribers.)

Have Profit Margins Peaked? (excerpt)

Both the S&P and the US Bureau of Economic Analysis reported that profit margins dipped during Q4-2014. The former was at 10.2%, while the latter was at 10.4%. But both remained near their record highs of the previous quarter. One of our accounts observed that data that I compile are showing a possible peak in the forward profit margins of the S&P 500/400/600. That’s not so clear for the S&P 500, where the margin peaked at a record high of 10.8% during the week of December 4, 2014. It did dip recently, but edged up over the past few weeks back to 10.6% in early April.

The dips are more noticeable and remain underway for the SMidCaps. For the S&P 400, the forward profit margin is down from last year’s peak of 6.7% during the week of June 19 to 6.2% currently. For the S&P 600, it is down from the 2013 peak of 6.1% during the week of October 3 to 5.5% currently.

The perceptive fellow who brought this to our attention wondered why margins seem to be coming down more for smaller than for larger firms. That’s a good question, assuming that the forward profit margins accurately reflect the situation. We think so. We calculate the data by dividing forward earnings by forward revenues.

The pace of employment has picked up over the past year. ADP data through March show that payrolls are up 2.9 million y/y, with large companies adding 546,000, medium-sized companies adding 1.0 million, and small companies adding 1.3 million. The additional payrolls may squeeze margins more for small firms than for large firms simply because add-to-staffs are more significant to the budgets of the former than the latter.

In any event, profit margins may be peaking across the board, though they aren’t likely to tumble until the next recession. If they have peaked, then profits growth will be determined mostly by revenues growth, which is likely to be below 5% this year and next year.

Today's Morning Briefing: On the Margin. (1) More stagnation than boom or bust. (2) Commodity prices stabilizing. (3) Six cylinders firing in Eurozone, but recovery remains lackluster. (4) Waiting for US consumers to spend gasoline windfall. (5) Japanese output remains disappointing. (6) Chinese exports and imports are shockingly weak. (7) Bad news for Brazil. (8) Signs of profit margin peak, especially for SMidCaps. (9) Hillary’s challenge: Six out of 10 say junk Obama policies. (10) Focus on underweight-rated S&P 500 Materials. (More for subscribers.)