A Macro Theme Worth WatchingOct 09, 2012
Chad Karnes, CMT
It's earnings season and expectations have never been higher. However, earnings margins are cyclical and today's margins are at 30 year highs. This historically has not been positive for the markets.
“Beware the Ides of March” Caesar was warned by a seer. As Caesar wrapped up his March activities in 44 BC, he became cocky and convinced the seer was wrong as he headed to the theater for the evening. “The Ides have come but are not gone” the seer reminded him. Caesar’s famous last words from that fateful day are captured by Shakespeare, “Et tu Brute?”
Caesar had a seer helping him when it came to his fate. Even so he did not listen.
We of course have no seers or magic crystal balls helping us when it comes to the markets, but we do have history.
The All Important Earnings
Earnings season for the 3Q has already kicked off and this week there are a few large companies reporting. On 9/10 there is Costco (NasdaqGS:COST), 9/11 is Safeway (NYSE:SWY) and JB Hunt (NasdaqGS:JBHT). 9/12 wraps up with some large banks like JP Morgan (NYSE:JPM) and Wells Fargo (NYSE:WFC).
This year’s S&P 500 reported earnings are expected to reach a new all time high at $90/share. For comparison, 2011’s reported earnings were$87/share and 2Q 2007 trailing (the previous stock market peak) was $85/share. By the end of 2013, analysts are expecting earnings to grow another 11% to another all time high of $100/share. Below are the latest S&P earnings for the past year and next year’s reported estimates.
It seems analysts and companies are all expecting continued earnings growth into next year as the above S&P data and headlines below support. But their earnings estimates are being met with some skepticism.
- “The Dow. Can Earnings Rescue Stocks?” – Motley Fool
- “Recession 2013? IMF Warns that Global Economic Slowdown is Getting Worse” - Huffington Post
- “Earnings Season Concerns” – Zacks.com
The Earnings Warnings
It seems the earnings that analysts are projecting mimics Julius Caesar - an overly cocky character. Like Caesar, analysts have ignored history's lessons by convincing themselves that earnings will continue to grow into perpetuity. But in reality, S&P earnings (NYSEARCA:SPY) are cyclical. They rise and fall over time based on macro and micro cycles. They do not move linearly through time as almost all analysts and companies assume in their estimates.
There is easy justification for this cyclicality. When earnings rise, so do margins. When margins rise, competition steps in as barriers to entry are now overcome. Competition then puts pressure on pricing. This lowers margins.
The below chart from Deutsche Bank outlines the cyclical nature of margins. Earnings margins have risen and fallen throughout their history and they have hardly been linear.
Margins peaked in 1989, 1999, 2007, and now 2012-13 (always preceding major stock markets peaks). I am not one to assume “this time it’s different” and am very cautious that earnings and margins at these elevated levels are not sustainable. We are starting to see some cracks in those lofty estimates already with recent guidance warnings by Fedex (NYSE:FDX) and Intel (NASDAQGS:INTC).
Et tu Earnings?
Looking at the above chart, not only do we see the cyclicality of earnings margins but we also see that earnings margins are higher than they have ever been since the early 80’s when the data begins. Margins at over 8% are another reason to be earnings cautious. Given the market is at 30 year margin highs, I would expect now more than ever for competitors to step in, lower prices, and pressure margins across the board.
Aside from the cyclicality of margins,the October and upcoming November issue of the ETF Profit Strategy Newsletter highlights 11 other mega investment themes along with tradable ETFs to take advantage of long term market trends.
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