As expected, July’s market headlines continue to roar along like angry lions even as volumes are withering on the City and Wall Street vine.

Well, at least those driven by actual humans.

The black boxes and algorithms will continue to push and pull on every headline.  So you really need to expect exaggerated moves as the media hype expands to capture the attention of an audience that is largely focused on the beach.

That said, there are a couple things I can send you off with as the summer winds beckon and the media makes sandcastles out of market molehills:

  • Try hard to overlook the emotional tug of the bearish horizon. Remember: Fear sells way batter than facts.
  • Though it may not seem like it, our economic and market fundamentals remain solid and resilient.
  • Positive earnings estimate revisions for the S&P 500 now stand in the 90th percentile.
  • Analysts, still extremely wary of getting caught being positive on what’s being cast as the eve of the next 2008-2009, remain well behind the 8-ball as companies are even more bullish than analysts in their own revisions.
  • Having been told for so long that the rise in earnings was all financial engineering - it is important for you to note while others will miss it - sales revisions remain very positive; which kind of deflate the bubble of fear that says US tax reform is the single driver of market momentum.
  • And don’t forget we are also seeing huge increases in CapEx guidance!

After nine years of share buyback ridicule companies across the landscape are shifting their investment to building for the future.

And it’s making the pool of stock much, much smaller for when all that growth kicks in.

It’s supply and demand folks, supply and demand.

The Latest on Earnings

In simplest terms, they keep on moving steadily in the right direction. 

So, while fearing the obvious slowdown in the pace of year on year growth rates will eventually become the thrust of all the fear-driven headliners, it is reasonable to expect the pace of growth to slow as the tax push burns off.

But the base continues to rise.

The quarter on quarter rise continues to evolve, closing in on the $168-$173 target we suggested back in January:

Mole Chart1

Then you have the weekly updates from Thomson.

Keep in mind that we have Q2 earnings already on the near-term horizon, as they kick off in a few weeks, which will adapt and change momentum in a few areas:

Mole Chart2

Thankfully, Calafia Beach Pundit Scott Grannis does a very nice job (as usual) of taking the data from the latest US Fed reports and putting it into a chart. 

The data backs up what Thomson is putting out, as it comes directly from the tax return / after-tax profits:

Mole Chart3

The chart above compares after-tax corporate profits to nominal GDP.

And we can see that, over the past three decades, profits have increased at a much faster pace than nominal GDP. 

In fact, we are over $20 Trillion now on GDP and the profits are accelerating as technology is being embraced at deeper and deeper levels in all operations.

And by the way - for all those who suggest markets are wildly over-valued and "ready for a crash," just let me know when that $10 Trillion sitting idle and earning Jack in bank accounts begins to move. 

This chart shows that what’s being propped up as "wildly over-valued" just ain't so:

Mole Chart4

Folks, this is going to be very tough but please you’ll need to work hard to not let all that fear-mongering spook you. 

The bigger these numbers get, the more frightening it may seem. That’s just stock market "Altitude Sickness" kicking in – the larger numbers mess with your brain.

And so, the chart above substitutes after-tax corporate profits using the National Income and Product Accounts for the traditional measure of GAAP profits (i.e., reported earnings).

Scott Grannis normalized the ratio so that the long-term average is similar to that of the traditional PE ratio – note the extreme overvaluation of stock prices in the late 1990s and into 2000 - the Tech Bubble days. 

We are nowhere close to those references, even though they sure sound scary.

In fact, today's valuations by this measure are very close to their long-term average. 

So, why use NIPA instead? 

Because it comes right off the tax filings, and usually companies try hard not to miss anything in reporting to the IRS.

“But Mike, why aren't prices racing ahead then?"

Well, there are lots of possibilities, but two (and a half) seem to be more likely than others:

1. After 2008-2009, anything that feels good is considered really scary and can't be true, which is the same emotion deeply felt for decades after the Great Depression.  Hence, everyone just worries about another collapse, correction or even a recession.

2. To be sure, all the chatter about Trump's tariff wars could get out of hand and precipitate a global recession.

2.5 In the end, to keep it simple, today's valuations can be explained away in one fancy sounding term which has been with us since March of 2009: “Risk aversion."

It sounds solid, well-thought out and smart.

But what it means is: “I am still scared to death.”

Mike Williams
Founder and Managing Partner

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