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Saturday, October 25, 2014 8:57:32 PM
Weekly Market Summary
By Urban Carmel
* October 25, 2014
While equities have recently become volatile, the underlying fundamentals have not changed.
Companies are nearly halfway through their 3Q reporting period. Since the end of 2013, earnings have grown about 6% while sales have grown less than half that (3%). That means margins have continued to expand, by about 20bp.
That 6% growth in earnings is equal to the change in SPX year to date. So earnings multiples are no longer driving the market higher as in prior years. Instead, the market is being driven, equally, by sales growth and margin expansion.
Coming in to 2014, many believed that higher wages and interest costs would begin to erode margins. That hasn't happened. But margins do appear to be flattening. 3Q margins are tracking 20bp lower than 2Q. That's noteworthy as the margins for small cap companies already started to decline last quarter (chart).
A flattening of margins should not be surprising. As it has been pointed out many times before, current margins are at an anomalous high relative to history. Some reversion or flattening is inevitable. And since the 1950s, a recession has not set in within a year of a fall in margins.
But it would imply a greater reliance on sales growth to pace future appreciation in EPS and SPX. That is especially the case since price/sales ratios are about 6% over the twin peaks in the prior bull market and about 15% above their longer term median.
The consensus expects 3.7% sales growth (nominal) for FY14 and also for FY15. The macro data largely concurs. We track the main macro data each month, and while stock traders will gyrate between euphoria and depression with each new data point, the trend has consistently shown growth to be ~2.5% real each month (read here).
A good recent example is real retail sales; for September, annual growth was 2.6%. It recovered from a soft winter but it hasn't surged as many expected. In fact, it's been relatively stable the past 2 1/2 years.
Wages, inflation and employment are all similar, showing annual growth very near 2%. Every month, traders excitedly anticipate non-farm payroll data (NFP). This is a volatile series but the overall trend hasn't changed in years. In September, payrolls grew by 1.9% yoy. Of note is that a 'miss' or a 'beat' of 80,000 in any month equals 0.05% of the US workforce; in other words, the monthly fluctuations are mostly noise.
So while equities have been gyrating, the underlying fundamentals in the US have not. But the picture is less attractive overseas. Growth has been weakening, badly.
To take one example, oil demand, a proxy for macro growth, is now growing at only about 0.6%, down from 1.8% just a year ago (chart from Yardeni). That's a two-thirds drop in the annual growth rate. More than 40% of SPX earnings come from overseas, but we haven't yet seen ex-US growth problems lead to slowing sales. If there is a watch out for equities, this is likely to be it.
All of the above implies that growth will remain positive but tepid. Treasury markets worldwide have been consistently signally this all year (from WSJ).
US equity market internals have also been signaling this. Equities are modestly higher in 2014 (small caps are down), but the sectors driving higher prices in SPX have been defensives and those that pay a higher yield (right side of the chart below). This is true whether you look back since the start of the year or just since the start of the second half. The current phase of the bull market is not being led by growth cyclicals. That's also a watch out, because defensive leadership is a classic late-stage signal (chart).
The benign view, which we ascribe to, is that the margin and multiple expansion phase of the bull market is largely over. Gains from here will be mostly driven by top line growth which is, again, positive but 2-3% (real). Another 60% gain, like that seen from mid-2012, seems very unlikely. A slower, choppier advance is how US equity markets have started to behave in 2014 and also how markets outside the US have progressed over the past two years.
http://fat-pitch.blogspot.com/2014/10/weekly-market-summary_25.html
George.
Click on "In reply to", for Authors past commentaries.
By Urban Carmel
* October 25, 2014
While equities have recently become volatile, the underlying fundamentals have not changed.
Companies are nearly halfway through their 3Q reporting period. Since the end of 2013, earnings have grown about 6% while sales have grown less than half that (3%). That means margins have continued to expand, by about 20bp.
That 6% growth in earnings is equal to the change in SPX year to date. So earnings multiples are no longer driving the market higher as in prior years. Instead, the market is being driven, equally, by sales growth and margin expansion.
Coming in to 2014, many believed that higher wages and interest costs would begin to erode margins. That hasn't happened. But margins do appear to be flattening. 3Q margins are tracking 20bp lower than 2Q. That's noteworthy as the margins for small cap companies already started to decline last quarter (chart).
A flattening of margins should not be surprising. As it has been pointed out many times before, current margins are at an anomalous high relative to history. Some reversion or flattening is inevitable. And since the 1950s, a recession has not set in within a year of a fall in margins.
But it would imply a greater reliance on sales growth to pace future appreciation in EPS and SPX. That is especially the case since price/sales ratios are about 6% over the twin peaks in the prior bull market and about 15% above their longer term median.
The consensus expects 3.7% sales growth (nominal) for FY14 and also for FY15. The macro data largely concurs. We track the main macro data each month, and while stock traders will gyrate between euphoria and depression with each new data point, the trend has consistently shown growth to be ~2.5% real each month (read here).
A good recent example is real retail sales; for September, annual growth was 2.6%. It recovered from a soft winter but it hasn't surged as many expected. In fact, it's been relatively stable the past 2 1/2 years.
Wages, inflation and employment are all similar, showing annual growth very near 2%. Every month, traders excitedly anticipate non-farm payroll data (NFP). This is a volatile series but the overall trend hasn't changed in years. In September, payrolls grew by 1.9% yoy. Of note is that a 'miss' or a 'beat' of 80,000 in any month equals 0.05% of the US workforce; in other words, the monthly fluctuations are mostly noise.
So while equities have been gyrating, the underlying fundamentals in the US have not. But the picture is less attractive overseas. Growth has been weakening, badly.
To take one example, oil demand, a proxy for macro growth, is now growing at only about 0.6%, down from 1.8% just a year ago (chart from Yardeni). That's a two-thirds drop in the annual growth rate. More than 40% of SPX earnings come from overseas, but we haven't yet seen ex-US growth problems lead to slowing sales. If there is a watch out for equities, this is likely to be it.
All of the above implies that growth will remain positive but tepid. Treasury markets worldwide have been consistently signally this all year (from WSJ).
US equity market internals have also been signaling this. Equities are modestly higher in 2014 (small caps are down), but the sectors driving higher prices in SPX have been defensives and those that pay a higher yield (right side of the chart below). This is true whether you look back since the start of the year or just since the start of the second half. The current phase of the bull market is not being led by growth cyclicals. That's also a watch out, because defensive leadership is a classic late-stage signal (chart).
The benign view, which we ascribe to, is that the margin and multiple expansion phase of the bull market is largely over. Gains from here will be mostly driven by top line growth which is, again, positive but 2-3% (real). Another 60% gain, like that seen from mid-2012, seems very unlikely. A slower, choppier advance is how US equity markets have started to behave in 2014 and also how markets outside the US have progressed over the past two years.
http://fat-pitch.blogspot.com/2014/10/weekly-market-summary_25.html
George.
Click on "In reply to", for Authors past commentaries.
Information posted to this board is not meant to suggest any specific action, but to point out the technical signs that can help our readers make their own specific decisions. Your Due Dilegence is a must!
gtsourdinis
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