Corporate profits

The Big Bull Market Challenge: Corporate Profits Stalled


The stock market’s historic uptrend after the election has come to a halt of late as the Republican healthcare reform bill stalled, raising concerns about the rest of the Trump administration’s agenda. However, the big mediums remain with a hair of record territory.

Investors have been spoiled lately with easy gains, a lack of volatility and a relatively calm news feed. Prior to last Tuesday’s drop, stocks had not suffered a 1% decline since October. Even the Federal Reserve’s interest rate hike, which came just three months after the last rate hike, was greeted by a big market rally. Optimism about global economic growth and reflation, and impatient anticipation of a Trump stimulus, have outweighed any concerns.

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But the fascinating recent gains mask a very frightening fact: Corporate profits remain at levels first reached three years ago. While stock prices have since risen, ignoring everything from renewed weakness in crude oil to accelerating Fed policy normalization, cyclically-adjusted stock valuations now sit at levels that were not exceeded until the stock markets approached 2000 and 1929. peaks.

As of March 16, “adjusted” 12-month earnings per share for the S&P 500 – which is actually an easier measure of profitability because it allows companies to add or remove items they consider to be events. “One-off” or otherwise unimportant. – was $ 106, according to FactSet. This is just a hair’s breadth above the level observed on January 31, 2014.

Since then, the S&P 500 has gained around 31% as investors are now willing to pay much more for the same level of income.

It gets worse when you remove the effect of aggressive stock buybacks. This method of financial engineering has been popular during this market cycle in part because it masks the timid growth in income and earnings by reducing the number of shares outstanding. Without it, based on FactSet data, the S&P 500’s total net income fell to levels first seen at the end of 2011.

Since then, the S&P 500 has gained almost 90%.

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Focusing only on revenue growth makes valuations even worse. For the 30 companies in the Dow Jones Industrial Average – excluding Apple (AAPL) and AT&T (T) since the former replaced the latter in the index two years ago – total incomes are now barely above the 2010 total, according to data compiled by Wolf Street. It’s true. Total sales of the largest US industrial conglomerates are at about the same level as seven years ago when the Dow Jones hit 9,614. It is trading just below 21,000 now.

Still, hope is eternal on Wall Street, as analysts forecast S&P 500 earnings growth of 9.0% for 1Q17 from a year ago. If this materializes, it will represent the fastest pace of earnings growth since the end of 2011, led by a significant rebound in revenues in the energy sector.

As we find out, that’s a big “if”.

Societe Generale strategist Albert Edwards, well known for his rare bearish streaks among brokerage oracles, warns that it is at this point in the business cycle that “adjusted” earnings measures “become more and more manipulated” as CEOs and CFOs are trying to hide the pressure on margins from factors like a tight labor market and higher interest rates.

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Another factor is the recent increase in inflationary pressure, which the Gavekal Research team said played a significant role in the “recovery” seen in the second half of 2016 that ended a two-year recession in profits. published from the S&P 500. In “real terms”, they say, there was “no recovery in earnings”.