David Rosenberg sings his own song. He does not sound very good:
Over half the S&P 500 have reported (304 to be precise) and so far the season has been rather jolly with 75% beating bottom-line estimates and even 63% doing likewise on the revenue line – both above average (of 70% and 60%, respectively in recent quarters). It now looks like EPS growth is going to test +50% YoY, which is impressive indeed. Companies are retaining more than 10% of their profits (post all operating costs), which is good news for bondholders, that is for sure. So why isn’t the equity market reacting better? A few reasons:
First, a lot of this good news was already priced in to begin with.
Strange statement after equities declined 15% peak to trough between April and July.
Second, the second quarter is a bit like ancient history right now – guidance has not been that good with three companies providing downbeat assessments for the coming quarter for every one that had something positive to say about the near-term outlook. Over the long-term, that negative-positive ratio is generally closer to two-to-one than three-to-one.
Other data services have a more positive guidance count. Let’s wait after next week to have the final count on guidance. Nevertheless, David is always advocating using trailing earnings. Now that they are stronger than he expected, using them in equity valuation is backward looking!
Third, analysts have stopped raising their estimates for the year – in fact, for every one that is doing so there is another one who is cutting forecasts. The future is muddled despite the nice things we see through the rear-view mirror, which is why the equity market has been in this tug-of-war lately. When the market was strengthening to the April highs, one of the catalysts at the time was that analysts were coming out of the Q1 reporting season at that time upgrading their EPS estimates three times faster than they were cutting forecasts
Analysts take a little time before adjusting their estimates after earnings season. Let’s see how things evolve in the next 2 weeks.
Fourth, while revenues have been above expected, they are running at about one-fifth the pace of profit growth and as a result margins are hitting new highs. What happens when they begin to compress (especially with 80% of the incoming economic data disappointing over the past month)?
For most of the year to date, David was worried about revenue growth. Revenues are better than expected which, with improved productivity, results in better margins, and now he complains about the risk of future margin compression.
Fifth, with the monetary and fiscal policy stimulus behind us, we can see what the economy looks like – back-to-back declines in retail sales, durable goods orders and shipments, and household employment. Not to mention consumer and producer prices. The era of consumer frugality never went away even in a flashy bear market rally
any more than it did just because the stock market bounced back 50% temporarily in 1930 (does anyone recall the great rally of 1930 or does that particular year invoke memories of shared sacrifice?).
Fifth and only solid point on that list. Economic uncertainty keeps investors cautious. A few positive stats and cheap stocks will draw them back quickly. Otherwise, equities will probably mark time around current levels. The risk is September/October …
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