It began with the usual fretting over “selling in May and going away.” It then ebbed into the Memorial Day kickoff to summer and meandered its way here – now, seeing the last few weeks of the thickest summer haze unfold. We made it through Brexit, several medium size “Black Swans” and now seem to be inching closer to yet another mother of all BS – the US elections.
JP Morgan is out with a piece this morning suggesting the elections are setting the stage for a major market setback. The chatter is endless. We have suggested one remain prepared for a setback – we hoped for a summer swoon. It may have been hidden in the 2-day setback from the all too feared Brexit vote. It may indeed still be ahead in the assured fretting as we get closer to a vote.
Either way, red ink is set to be opportunistic to long-term investors for several reasons.
Heartbeat and Trepidation
How many times have you heard something like this?:
“Up next is Ralph Jones who warned us of impending market doom just before the recent two-day, 1.27% selloff from record highs in the markets. With growing concerns still present over Brexit, the expanding breakout of the Zika virus, Fed Minutes unrest and the sure to be nasty surprises on the upcoming US election, where do you see markets going from here Ralph?”
Come on – you gotta chuckle at this stuff – even as markets have still not traced back into the previous trading range. By the way, I find the latter quite surprising – but still hope to see it unfold.
The point? It is this very type of talking head banter that keeps so many believing in the crystal ball. There is this constant search for that magic pathway which will provide solid returns with no risk, no pain while completely side-stepping anything remotely painful.
I once typed in an equation for this: E – R = S
Expectations – Reality = Stress.
If we plan effectively, focus on the proper waves of change ahead, do so with patience and discipline and EXPECT only that we must take the ugly with the good on the pathway toward investment accumulation success, then we might be utterly amazed at the reduction of stress levels.
We have suggested for quite some time that the baton is being passed in the demographic power-drivers of the US economy unfolding ahead. Much will change – much is changing.
This process is being mixed in with poor fiscal policies and far too much focus on the Fed and rates. Meanwhile we have turned this potent mix of misunderstanding into a toxic level of fear, surely capable of causing a short-term, rude interruption at any stage along the way.
Not, mind you, because of economic momentum but more because of fear.
One can almost feel the itch…the sensation of something about ready to break. We have feared for so long that if too much time goes by without a problem to fret over – we will create one if need be. Like a junkie looking for the next hit – painful as it may be – the mass audience is addicted to fear.
It will likely be years from now that we will look back and understand more clearly. In the meantime, long-term investors can be immensely grateful for the fear, the impact of which has kept rates at record lows and should do so for longer than currently anticipated. This has permitted a complete remake of the underlying debt burdens (and more importantly cash flow costs of same) for corporations and consumers across the land.
Earnings Recession Banished?
Sure seems that way to us. Just as the worst of the summer haze envelopes us all – and while new fretting is over the elections and Zika – the old monster of earnings recession seems to be suffering the same death all other monsters have in years past.
Let’s cover some data:
The chart snapshots following this brief summary are from Dr. Ed and his great team. They show very helpful perspectives on reported earnings, margins and revenues. It provides you a confirmed sense that the bigger picture on the recent “earnings recession” was an event almost completely driven by the setbacks in energy.
The headwinds associated with the setbacks have now mostly abated and almost completed their round-trip of the worst numbers. As such, improvement is in the cards.
As we all know, S&P compiles both revenues and reported (unadjusted GAAP) earnings for the S&P 500. Dr. Ed’s charts highlight that the latter peaked at a record high of $27.47 per share during Q3-2014. The ensuing nearly six-quarter earnings recession coincided with the collapse in oil prices and in the S&P 500 Energy sector’s earnings as noted here many times.
A review of the stats shows these elements seem to have troughed late last year. Since then, earnings have rebounded steadily during the first half of this year as crude prices stabilized. This is yet another sign suggesting that the worst of the energy-led earnings recession is behind us.
Note this is also confirmed by S&P 500 revenues, which was negative on a year-over-year basis for most of 2015. During Q1 and Q2 of this year, that growth rate turned positive – to 0.3% and 1.1%.
If one excludes energy earnings from aggregate revenues, they actually rose a larger 2.2% y/y during Q2.
Importantly – and missed by a vast portion of the expert crowd – growth rates in aggregate S&P 500 revenues (excluding Energy) remained in positive territory throughout the recent earnings recession.
More important as one can see from the chart summaries: The bottom line is that excluding the energy sector setbacks, this last 18 months has been more about a “recession” in the pace of growth of earnings rather than an outright recession in earnings.
Re-read that last sentence…let it sink in.
A note on Margins
The overall S&P 500 profit margin edged back up to 10.3% during Q2.
While the bearish chant during the “recession” was that margins would assuredly fall, this has simply not been the case. As shown in Dr. Ed’s charts below, they continue to hover in record-high territory around 10%, as has been the case since Q1-2014.
Note lastly that forward earnings and forward revenues seem to be on the verge of achieving new highs – even as they have been chopping around near records during most of the time since the late 2014 peak.
These next few weeks will be the murkiest of the summer. That is not new – they always are just before the final Labor Day break. Do NOT be surprised by chop and even louder news events. Volume in markets will be very choppy – while volume on market stories will be loud, designed to get your attention. This type of thing can set the stage for odd, knee-jerk reactions.
Stay focused, be patient, remain disciplined. As has been the case for sometime now, the more important underlying data remain strong. This market is set for continued surprises to the upside as sentiment remains tepid at best – and shrinks back immediately with any red ink.
Patience in the Doldrums
Use that to your advantage. Even as we still root for a summer swoon – an early Fall swoon is just fine as well.
The demographic structure of the US is significant, world-leading and rare.
This slow-moving but persistent strength will overcome the processes we are seeing near-term – positioning us well for the decades of demand ahead.
Pause for a moment and think demographics – not economics.
The future is far brighter than many care to accept today – even as trouble will always be included in the pathway, whether we like it or not.
Yes, so far, the hoped for summer swoon has evaded us. But elections are still ahead.
Alas, maybe that summer swoon to take advantage of can be hidden instead in the Sept/Oct time window. I say – Be ready.
Tomorrow a review of this year’s growing revolt against hedge funds – and more on sentiment advantages.
Until we see again, may your journey be grand and your legacy significant.