Enjoying the roller coaster? Hey before I try to call the future – one note of importance as I dust off this old crystal ball:
“Trying to predict the future is like trying to drive down a country road at night with no lights while looking out the back window.”
– Peter Drucker
Mr. Drucker is also to have been known to state:
“The future has already happened.”
So there you go – both ends of the spectrum have been covered for the compliance agents and the crystal ball is ready and the batteries have been replaced.
Damage Done?
We have spent so much time fretting over cheap oil (God that still makes me nuts when I have to type it – crazy guys, really crazy), many may have lost sight of what type of impact it has already had and how much more it can have on the future.
These thoughts may help – but first, one more note. I paid $1.98 cents per gallon of gas yesterday for the first time in many years. Not a single spec of me thought that was a bad thing.
We have been repeatedly told we are facing a world-ending, economy-death-knell “profits recession”. Good Lord, if these media guys did not have all these fancy headings to keep filling space with, what the hell would they do.
So to highlight – and skewer the idea that we are having a “profits recession”, I hereby officially borrow a few very well made points from Dr. Ed this morning:
“The global economy is growing at a sub-par pace that may even be slowing. Commodity prices have been tanking since mid-2014. The dollar has been soaring since then. No wonder there is so much speculation about an earnings recession going on. If that’s happening, then we should be concerned about an economic recession.
Profitable companies expand employment and capacity, while unprofitable ones shrink both. There are very strong correlations between the y/y growth rates of S&P 500 forward earnings and those of both aggregate hours worked and real capital spending. Of course, causality runs both ways, but the importance of the profits cycle in driving the business cycle is often ignored by Washington’s politicians and their macroeconomic advisors.”
The more important stuff?
The yearly change in forward earnings did turn slightly negative during June last year. And it is up just 1.1% y/y through the week of January 21.
However, the S&P 500 isn’t in a profits recession excluding the earnings of the Energy sector. The Energy sector is weighing down earnings as measured by both Standard & Poor’s (SP) and Thomson Reuters (TR).
Let’s have a look at several measures of aggregate earnings:
(1) NIPA profits. According to the National Income & Product Accounts (NIPA), after-tax corporate profits based on tax returns rose to a record high of $1.84 trillion (saar) during Q2-2015, a solid gain of 8.5% y/y (Fig. 3). It did dip 3.3% q/q during Q3-2015, but was still up 1.3% y/y.
NIPA also calculates after-tax profits from current production. It has been essentially flat since Q2-2012. Nevertheless, corporate cash flow has been edging higher into record territory, totaling $2.12 trillion (saar) during Q3-2015.
(2) S&P net income. SP compiles a series for the total net operating income of the S&P 500. It peaked at a record annualized rate of $1.1 trillion during Q3-2014. It’s been down each quarter since then by 14.7% through Q3-2015 to the slowest pace since Q4-2012. All of that apparent profits recession is attributable to the decline in the net income of the Energy sector.
Drop the Headwind From Our Thinking
Dr. Ed continues with his points:
“The Energy sector was a major drag on overall S&P 500 earnings last year. SP’s data show that S&P 500 earnings dropped 14.1% y/y during Q3. However, removing Energy turns this figure to a positive 3.4%. TR’s story is less pronounced, but directionally the same. S&P 500 earnings dropped 0.7% with Energy, but rose 6.8% excluding it, according to TR’s account for the same period.
Furthermore, consider the following:
Energy’s lower earnings share. The price of Brent is at a strikingly low $31.66 per barrel, having fallen 72% since the summer of 2014.
(The good news is that even if oil prices should fall further, that wouldn’t have as much of an impact on S&P 500 earnings as oil price declines of similar size did last year. That’s because the earnings share of the S&P Energy sector dropped from a cyclical high of 14.9% on August 4, 2011 to a record low of 3.3% as of mid-January.)
Meaning, if oil dropped another 30%, it would have less than a 1% impact on the SP 500 earnings.
Most important of all – and a dagger in the heart of the profits recession fear-mongering:
The latest weekly data through January 14 compiled by TR for S&P 500 total forward revenues and forward earnings can be used to show the impact of Energy on these two aggregates (not per share).
Aggregate forward revenues excluding Energy was up 2.8% y/y to a record high, but down 0.9% including Energy.
Similarly, aggregate forward earnings was up 3.4% excluding Energy and in record-high territory, but down 0.5% including Energy.”
Now We Can Just Fear The Fed
Obviously, all eyes will be on every syllable in the FED statement today. I’d like to think they will stand tall and scare away a few more nervous nellies for one last dash into the cold water. I repeat from an earlier note:
While I would love to think that the panic has run its course – I thing we will end up preferring it lasts a bit longer. I am not suggesting that it needs to go down a lot more. I am suggesting that the long-term investor would prefer to simply see it take awhile to go back up.
A couple tests of the lows and on lower volumes would be a sign that the push is dissipating and would be good for building for the long haul.
So Where Does This Put Us?
Imagine this for a moment. You are on a long bus ride on a very lengthy pathway. There are potholes, flat tires, breakdowns and detours along the way – all the way up this huge mountain trail.
But when you get to the top you recognize the purpose of getting through all those events on the way up. You realize it surely would have been foolish to dis-embark during one of those frustrating periods to walk back down the mountain.
You realize you would have missed the rewarding view from the top….even though part of the trip sucked.
Right now, we are on a lunch stop. Enjoy it.
The monsters we are fearing will come to a close and this chapter of fear will end. No rest though – be forewarned.
When we are completely done wrestling these monsters to the ground and watching them turn to dust, the next chapter has even bigger monsters.
They are uglier, more dangerous, worse for our future and scary as hell. Most of all, they will once again convince us that “it’s never been this bad.”
More later.