After the market turbulence of the last few weeks, it’s probably time to read those tea leaves/runes and take a stab at working out what the hard data is telling us about what might happen next to markets. As usual this week we have a mix of both good and bad news – plus the inevitable red herring.
Let’s start with that last fishy red herring – quarterly profits measures. Even President Trump has his doubts about the usefulness of quarterly earnings (and their accompanying estimates). Like GroundHog day we usually wake up after a bout of market volatility and re-assure ourselves with recent earnings numbers.
“Gosh, the world seems to be going to hell in a handcart, yet profits are actually increasing?”
Shurely shome mishtake, as Private Eye might say.
Except of course those quarterly estimate “beats” are largely an exercise in futility. They are about as useful in forecasting terms as a chocolate teapot. For some evidence of this look to the current reporting season which has now been running for almost three weeks, and so far, US companies are – mostly – managing to beat the analyst’s numbers. Shock horror!
According to Deutsche, we need to take these numbers with a pantry sized pinch of salt. They’ve looked at data going back to the 1980s and found that “more than half of U.S. companies always surprise the markets – every quarter, whether the economy is in an upswing or a recession. More recently, over the past three years, 73% of U.S. companies have on average exceeded their forecasts.
“The reaction of the S&P 500 in the first four weeks after the start of the reporting season during the past five years, of which we only show three years, has been largely detached from the beat ratio (the ratio of firms that were able to beat the forecasts). The correlation of both data series is close to zero….In the current quarter, the discrepancy is particularly striking: a record 80% of U.S. companies were able to beat the forecasts, but, after Wednesday’s selloff, the S&P 500 is down by 8%. “
Deutsche draws three conclusions from this worrying data:
- “Neither as an indicator for the market reaction nor as an indicator for the quality of the quarterly figures is the “beat ratio” of much use.
- This is primarily due to the fact that companies are very successful at expectations management and guide analysts down just ahead of quarterly reporting.
- An independent, quantitative and qualitative analysis of the quarterly figures is therefore mandatory. “
But what IS useful about the current bout of earnings number is that they confirm a much more ‘credible’ story, which is that the US economy in particular is in pretty good shape. Which is why profits are holding up. This would suggest to me that the current correction is probably a tad overdone.
If we are looking for proper ‘red flags’ perhaps should probably look elsewhere.
What about inflation? Is that galloping away? I would suggest that the jury is well and truly out.
Graham Bishop from Heartwood IM reminds us that despite what the hawks say inflation does seem to be under control – although most measures are on the rise. “While not insignificant, today’s levels do not represent a rampant inflationary environment; inflation remains a world away from the double-digit levels last endured in the 1970s. What’s more, inflation over the past few years remains consistent with central bank plans for low and stable levels, aimed at enabling the conditions for robust, sustainable growth.”
OECD core and headline CPI
The other good bit news according to Bishop at Heartwood, is that the US T Bond gap has stopped flattening. If the gap (or ‘spread’) between these yields actively inverts, it generally signals recession ahead. Happily, according to Bishop, “the recent flattening of the yield curve (i.e. a narrowing of the spread between 2-year and 10-year Treasuries) now appears to have eased, with yields beginning to diverge once more. …This is a heartening, even if temporary, sign for the economic outlook. It is also important to remember that even an inverted yield curve should not signal an imminent doomsday – this would be a leading indicator pointing to recessionary conditions over the medium term.” Bottom line – no need to panic just yet!
The yield curve is not flashing red
2-year and 10-year US Treasury spread
Al of which brings me back to my caution about reading too much into any of the headline numbers – I’d wager that we’re almost certainly looking in the wrong place for the next crash. Albert Edwards at SocGen, by contrast, thinks we should focus more on China. Most of us, including Edward’s, have got China consistently wrong over the last few years – we’ve doubted the resilience of the economy and the ability of the state planners to turn on (and off) the credit tap. But Edward is concerned that this run of good luck may about to come to an end. The headwind? The recent swing into current account deficit “makes China’s policymakers’ job even harder. “ Edwards also notes that ” Most worrying of all for Chinese policymakers is that the economy has slowed to the point that employment has begun to fall, most visibly in the slump in the latest employment component of the PMIs (both official and Caixin). The shedding of manufacturing jobs has been apparent for a few years now (ie sub 50), but if the services sector is also now shedding labor again, then that is really serious for policymakers”.
Eye’s East everyone?