All the Battles Being Fought on Emotion…
It’s hard to believe that Q3 earnings will start up in just a few short weeks.
And we suspect it will be the last "not very pretty" quarter as the round-tripping of tax-bump benefits is just about complete.
Come Q1 and Q2 of next year expect a lot of chatter about "easier comps" from many of the media experts.
For now, it’s the usual downgrading of expectations as the bar will be set low for Q3 under the strain of "tariff concerns", "trade uncertainties" and any number of other shenanigans hitting the windshield at high speed.
So, what does Q3 look like now?
As each new quarter kicks off, the (next 4 quarters) earnings rolling forward tends to get a bump - only to be written back down in preparation for misses that often don't come.
Of course, with everyone and their brother now expecting a recession the quarterly increases are getting little to no airtime.
So long as we can swallow a few extra TUMS the numbers in general remain surprisingly healthy.
When the quarterly roll takes place on October 1, 2019, the new forward 4-quarter estimate will thus be Q4 2019-Q3 2020, and that current estimated value is $176.25.
On a calendar basis, which is probably an easier conceptual view, the years looks as such:
- 2020: $182.66 (estimated) year-on-year growth is expected at 11%
- 2019: $164.30 (estimated) year-on-year growth is expected at 1%
- 2018: $161.93 (actual) year-on-year growth of 23%
Remember that on December 31, 2017, we ended the year with about $137 in S&P 500 earnings, and the NYSE Composite (broader market without the focal tech impact and heavy weighting) stood at 13,006.00.
That compares to today's current number for the NYSE as of Friday at 13,094.00.
And yet earnings are solidly higher, falling somewhere between $164-$167 by years' end, and even a bit higher than that by NIPA standards.
In other words, during a period of time when an unbelievable number of "problems" have rained down on us in the media, earnings have risen from $137 to $165 with almost no improvement in the net value of the market as a whole.
This is not the way uptrends tend to end:
- Almost all investors "nervous" or "concerned"
- Levels of cash demand so high for bank accounts that reserves are getting squeezed
- Low borrowing demand
- Paltry investor sentiment, and
- Massive inflows into bonds and out of stocks...
All under the umbrella of these types of increased earnings bases supporting the market's valuation perspectives.
Durables Still Solid
Our friend Dr Ed Yardeni and his team always do a great service of keeping folks on the leading edge of the underlying strength perspective.
In the case of the consumer all seems solid as jobs are plentiful, salaries are high, earnings are increasing steadily, and quit rates imply that job seekers are confident.
All of this, of course, can explain the strength in retail sales which seem to regularly see 6% increases over the last two quarters. And that’s before what can be expected to be a blowout holiday shopping season.
We can also see this steady confidence in the durable goods order data (less aircraft orders), which while stalled at highs continue in record territory:
This is also likely to continue if we look at the structure of corporate profits; even when allowing for the cloudy nature of all the tariff chatter.
By the way - this chatter will not "clear" until after the fact, and well after prices have already risen again, and we are beyond this trade tariff funk.
The chart above divides profits by GDP.
Note that for a very long time - from 1959 through 2001 - corporate profits tended to average about 6.0% to 6.1% of GDP, and they were mean-reverting around that value.
Since 2001, however, they have averaged 8.7% with no signs of a mean reversion to 6%.
Today - we are nearing 9%!
This tells us that underneath all the noise and concern, while all the battles are being fought in our emotions, corporations these days are generating profits on a scale never seen before 2001.
Also, for the past 17 years corporate profits have averaged a higher percentage (about 40% higher) of GDP than they ever saw in prior years.
That translates into a roughly 40% increase in profits when measured against GDP.
One Last Look at Profits
The final chart (above) shows both measures of profits by using two y-axes with similar ratios and a semi-log scale.
Note that the "gap" between NIPA profits and EPS profits has closed rather dramatically in recent years.
Much of that came about thanks to a downward revision to past years' NIPA profits announced earlier this year.
In any event, both measures of profits seem now to be tracking each other more closely, and both give rise to similar P/E ratios.
Neither measure suggests that equity valuations are excessive.
Now sure, you can argue that P/E ratios are above their long-term average while bonds are significantly below their normal yields, as we fight off the deflationary pressure of Gen Y.
But profits are in general far more abundant, relative to GDP, than they have ever been over the long haul.
What's not to like about this?
In the end, all the angst and cloudy perspectives brought on by the "Trade Tensions" will have corporate entities becoming far more efficient and productive - getting more prepared to bypass this hurdle and ready for the next one.
And there is always a next one.
My hunch? There’s some more chop ahead - maybe another dip during the earnings parade and then a race to the finish as we head into the brave new world of the 2020's.
But, as is always the case, the winning investors in the long run are the same - patient, disciplined and able to overlook the incessant, wasted noise designed solely to throw you off your path.