One of the main Bullish arguments has been that very strong Earnings are not signalling a major slowdown.
I find that argument disingenuous. Earnings have been very strong on a year over year basis; but they have also been disproportionately concentrated in a few sectors (Energy, Materials) and partially engineered through dramatic share buybacks.
Marketbeat looked at some details last week, and came up with this:
So, it was a good quarter for earnings, right? Not necessarily, if you look at the entire spectrum of publicly traded companies. Sure, the S&P 500, with more than 97% of companies reported, has posted earnings growth of about 13%, marking yet another quarter of double-digit earnings growth. However, looking further down, the picture isn’t quite as positive.
The Wall Street Journal’s industry-by-industry quarterly earnings page (available here) shows that, with more than 3,700 companies reporting, net income growth on a year-over-year basis was up 12% in the second quarter, compared to 19% year-over-year growth in the first quarter (with more than 4,100 companies considered).
However, the growth in the first quarter was much broader than in the second, when energy and financials ruled the roost. Energy companies have recorded 50% growth in net income, while financials grew by 19%. Exclude those two groups, and net income is down 1.1%, in part due to significant dropoffs in basic materials (down 12%), consumer goods (off 11%), health care (37% lower) and technology ( down 4%), and a 13% decline in telecommunications.
It didn’t look this way in the first quarter. While it is true that energy and financials rocked there too (up 44% and 13%, respectively), when taking those out, net income for the remaining companies rose 17%.
This pattern doesn’t hold with the companies in the S&P 500. All of S&P’s 10 main sectors are showing income growth on a year-over-year basis in the second quarter, according to Thomson First Call; health care and technology are the laggards, with 9% growth.
"When you look at the S&P 500, bottom line, it’s not bad, and across the entire spectrum it’s an up quarter," said Vinny Catalano, president of Blue Marble Research. "But when you get into the mid- and small-cap issues, as these data show, you really had a collapse…second-tier issues have deteriorated." (emphasis added).
As we noted a few weeks ago (Rotation Underway: S&P100 to S&P600), the Big Cap stocsk have (finally!) begin to outperform the smaller caps.
The above earnings discussion helps to explain why.
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UPDATE: August 28, 2006 12:45
The Capital Spectator makes some interesting observations about earnings:
"Last year, income advanced nearly 23% over 2004, making the year one of the more remarkable 12-month stretches in corporate history. Curiously, the stock market reacted rather sheepishly, with the S&P 500 climbing only 4.9% last year. Perhaps it’s not so curious after all. The stock market is widely credited with looking ahead. Sometimes it sees things that don’t materialize, but in 2003 and 2004 its powers of prognostication were prescient, or so the S&P’s 29% and 11% total return for each of those years, respectively, suggests.
Indeed, earnings continue to impress relative to the past. But the fuel that powers those earnings–rising corporate income–is showing signs of slowing. For this year’s first quarter, corporate income slowed considerably relative to the year-earlier quarter, rising by 13%, as the chart above reveals."
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Source:
About Those Earnings
David A. Gaffen
WSJ, August 25, 2006 12:02 p.m.
http://online.wsj.com/article/SB115650770612045482.html
You posted a chart from the St. Louis Fed a while back that made the case quite effectively, I think: corporate profits, as a share of national income, are in a very atypical spike. So if people are looking for double-digit growth going forward, they need either double-digit growth in national income (yeah, sure) or an even more extreme spike in the profit share. One can hope for that more extreme spike, but if we’re not at the last gasp yet, we’re surely getting close. At best you get maybe a few more quarters of good earnings followed by some desperately disappointing ones. Not a bet I would want to take.
If profits aren’t mean reverting, then capitalism is broken.
Time for a paired trade:
Long Socialism
Short Capitalism
About Those Earnings . . .
I want to add a little bit more to the earnings analysis made by Barry @ Big Pictures. Hes saying that though earnings of U.S. companies are growing at double digits, they are more concentrated in financials and energy.
But let dig a litt…
“Earnings have been very strong on a year over year basis; but … and partially engineered through dramatic share buybacks.”
Talk about permabears, how can some one complain about earnings being strong or “engineered” because very profitable companies are buying back shares. I feel so sorry for the shareholders of these well run firms. Why do people buy into this negative view????
>>> how can some one complain about earnings being strong or “engineered”
Yes, the earnings can be engineered by cutting capital spending, i.e. future growth, and this is what we see. See my article posted above in trackback section.
Sean, if your paired trade does not work out and profits don’t revert to the mean, then not only is capitalism dead, but feudalism is back with a vengeance.
I am as bearish as anyone, but isn’t the sad fact that earnings are always “engineered”???? It’s what the market is willing to pay for that magical/ridiculous E, or the trend thereof, that counts, not the E in and of itself. IMHO. Perhaps the market is currently discounting a future where even the oils and banks do not earn as much? FWIW.
knzn,
Arguably, globalization is giving US companies a windfall spike in real profits (and an even more pronounced effect in nominal profits) by giving the US worker a negative spike in real wages.
This spike — a windfall to the top 2% that can now afford to pay less to the bottom 98% — might go on for a long time.
-wunsacon
Barry is using the exact same logic that he disputes whenever he talks about inflation. When earnings are up because of oil and gas, he complains that earnings everywhere else are not rising that much. But when core inflation is rising slowly, he complains that it’s wrong to exclude energy and commodities. Which is it Barry? You can’t argue that energy needs to be included in inflation and in the same breath imply that including it in earnings gives a false picture. Personally, I can’t fathom how you ever exclude energy — in earnings or inflation.
We can discuss inflation and energy ad naseum or simply look at the price of gold and oil (trends over various timeframes). FWIW (double meaning intended).
The NYT headlines with a story that says the percentage of GNP going to workers is down.
The Republican view is that this is good, that wages are parasitical and the only income which should be taxed, since other incomes increase wealth.
We shall see how it works out.
Anonymous, FIRST we had oil and gas inflation. NOW we have core inflation rising rapidly and right into the pockets of big business as they raise prices, but not wages commensurately. Hello! It’s called corporate welfare. Next time read Barry more carefully!
I would think rising interest rates should inflict some pain on financial earnings from here on.
As far as energy earnings, this is good for the owners but I foresee little increase in investment from it.
teddy,
I did read Barry carefully, and nowhere in his post do the words CORPORATE WELFARE appear. Only in your response. How on Earth did you twist Barry’s original assertion that earnings are concentrated into a few sectors into a populist rallying cry?
Furthermore, you practically refute his entire point. Barry’s post is about his concern that earnings are decelerating in most sectors and that the strength in energy masks that weakness. How does that happen? How do earnings decelerate? It happens when a concern or an actual slowdown businesses to worry about raising prices while at the same time their costs (read that as “wages”) are rising. That’s the exact opposite of what you say. If you were right — prices rising faster than wages — corporate earnings would be accelerating!
Besides that, I merely pointed out the inconsistency of Barry’s arguments. He wants energy factored into inflation because leaving it out is misleading. But he wants it excluded from earnings, because leaving it in is misleading. You turned it into something entirely different.
By the way, I don’t disagree with most of what he says. I just want him to be consistent.
Anon, I can not see any argument in BR’s post for the exclusion of energy from earnings calcs, all I saw was a demonstration of the point he was making that earnings growth has been very narrow (large cap oil and financials). Were you referring to something he said elsewhere?
anonymous:
costs (read that as “wages”) are rising.
you can read that as “wages”, but you’d be missing a giant elephant known as “energy costs”.
to your point, though: if you strip out the energy sector out of overall earnings growth, the remaining market sectors don’t look all that hot. it’s not a contradiction, it actually strengthens the point. a huge chunk of growth is going to one sector (whose goods happen to get dropped from the core inflation rate). the others look better when averaged with it.
Anonymous, all u have to do is put 2 and 2 together. Hasn’t been Barry talking about the distortions in the CPI for 2 years? Hasn’t he been talking about the stagnant wages and the housing bubble for 2 years? Well, that housing money was sucked out of the homeowner’s equity along with profits from a rising CPI into wall street coffers. And wall street and the fed didn’t start squawking about inflation until 2 quarters ago when wages started to rise which started to crimp company profits. Barry has been talking about the possible popping of the housing bubble for quite a while now. Where were you? That my friend is why the market’s profits are slowing.
” housing money was sucked out of the homeowner’s equity along with profits from a rising CPI into wall street coffers ”
explain that please Teddy
>>>Besides that, I merely pointed out the inconsistency of Barry’s arguments. He wants energy factored into inflation because leaving it out is misleading. But he wants it excluded from earnings, because leaving it in is misleading. <<< Anonymous has a good point. And in attacking him other points have been brought up, but no one has addressed his point directly.
Dl, if wages were keeping pace with GDP, then housing wouldn’t be in quite as bad shape. Paul Volcker, besides worrying about creation of a banana republic economy, recently said he was concerned that real wages in the last 35 years have been flat. Well, if non- core inflation was truly recorded, then it would show that in the last 2 years, real wages are not flat, but truly negative and only the housing market kept the economy afloat. How can we as a nation have negative savings rate and a growing economy if this were not the case?
I don’t see anyone arguing that the energy/financial earnings should be excluded…
What I see is an argument that if we look deeper into the earnings growth story, we see that it is more flimsy that the headline reading leads one to believe.
It is analagous to an index hitting new highs while the internals deteriorate. (i.e. Dow hitting new highs with A/D declining). Look beyond the surface and the rosy picture might not be so swell after all.
I don’t find any inconsistency. If you take the share buyback issue and examine the deeper meaning…why are these companies not expanding capacity, paying down debt, or otherwise investing if future economic growth looks good? Instead they are buying back shares to offset grants and juice the “E”.
Why the vitriol? Maybe the inconsistency is in a few peoples’ reading comprehension and analytical abilities.
“Smug arrogance does not win a whole lot of friends amongst those who live beyond the beltway, where – Core rate be damned – real families must buy food and energy.” Barry on August 18
It’s Barry on August 18. There, he complained that core CPI is misleading because core EXCLUDES energy.
“Energy companies have recorded 50% growth in net income, while financials grew by 19%. Exclude those two groups, and net income is down 1.1%…” Barry on August 28
That’s Barry on August 28. Now he says earnings figures are “disingenuous” because they INCLUDE energy.
That’s inconsistent. Forget the extraneous economic arguments, which can be debated ad nauseum. Look at his inconsistency. When it suited him last week, he complained energy was not included. Today he complains that it was.
No inconsistancy, just rotting interiors. Sometimes truth isn’t always nice.
I don’t see the inconsistency either and this appears to be the creation of an argument for argument’s sake, a tactic that is getting repeated frequenly here lately. I am beginning to expect that this is a coordinated effort. Barry and his blog must be getting under some thin skins.
“expect” = suspect
Excellent article by Dan Fitzpatrick in today’s RealMoney.com – “Housing Industry’s Hidden Cracks.”
Anon – the point is that energy is having a profound effect on both earnings and inflation. In fact, Barry has argues FOR the consistency that you refer to many times in the past 6 months. i.e. to those that cite SPX earnings growth rates as being strong and growing x% YOY, Barry has commented that the growth is almost entirely attributed to the ENERGY sector…. and as those same individuals would argue for inflation ex-energy, Barry has said they can’t have it both ways…. IN for earnings, but OUT for inflation.
He’s pointing out the impact AND the inconsistency
…….and energy has most likely peaked, with its earnings due to fall.
Ignorence seems to be your best suite “Mike L”, if anything the signs of decline to 9000 by November have increased. You obviously aren’t getting it.
Earnings growth will continue to be strong, if not spectacular. The fed is poised to CUT rates next year. What’s more, the market is not expensive.
That sounds like a recipe for a big rally. Where’s the flaw in my argument?
” housing money was sucked out of the homeowner’s equity along with profits from a rising CPI into wall street coffers ”
please explain the ” into wall street coffers ” part teddy
Dl, let’s go back to Barry’s original post today. The S&P 500 companies are still recording profit growth of 9% for the 2nd quarter yoy according to Thompson First Call, while the smaller companies are suffering. The big companies have been able to pass their inflation costs on to the consumer. We all know that a large part that “growth” (GDP)was inflation which was not acknowledged by Wall Street. The wages that were generated just were not capable of this growth w/o extraction of home equity which most on Wall Street don’t want to admit. In the very 1st comment today, Knzn noted that the St Louis Fed said that “corporate profits, as a share of national income, are in a very atypical spike”. I think that the St Louis Fed said it more elegantly than I ever could,
wow @ some of the borderline/openly communist statements in these comments.
“Time for a paired trade:
Long Socialism
Short Capitalism”
uhhh good luck making money in the market if you don’t believe in “capitalism” (which is a misnomer btw)
from barry’s post: “Sure, the S&P 500, with more than 97% of companies reported, has posted earnings growth of about 13%, marking yet another quarter of double-digit earnings growth.”
what more do you need to know?? the world economy is booming like never before due to advances in technology and free markets. even if barry and other permabear are right and earnings growth SLOWS to say 7% that would not be cause for panic. we are only beginning to reap the economic benefits of computer and internet technology
if anything this article shows the massive cult of negativity perpetrated by MSM liberals, which is weighing our markets down more than anything else
Teddy
answer the question about that “quote”
In capitalism it is very common for earnings to go NEGATIVE every handful of years, and the long term real earnings growth average less than 3%
But market history has been tainted by the MSM liberals and may be permabear too.
And I think this is just the beginning… Of a new era..
Of 13% profit growth……ok ok only 7%
“…shows the massive cult of negativity perpetrated by MSM liberals, which is weighing our markets down more than anything else”
Good grief, it’s not bad enough that cult of the man-cow trolls are coming out of the woodwork, now we’re getting dolchstoss (cf. http://harpers.org/StabbedInTheBack.html ).
Lord, give me the strength to remain rational under the onslaught.
wow, it is becoming more and more apparent we need some sort of registration here.
“what more do you need to know?? the world economy is booming like never before due to advances in technology and free markets. even if barry and other permabear are right and earnings growth SLOWS to say 7% that would not be cause for panic. we are only beginning to reap the economic benefits of computer and internet technology”
Maybe you should read up on the business cycle. We’re not due for what you expect.
“Stock”, is that short for stock broker? Is it a new era? Maybe a new paradigm? As Yogi would say, “It’s like deja vu all over again”.
stock is for i’m short the market
how about answering the question instead of dancing around it for a change
>>>Barry, time is running out on even a sub 10000 dow by years end, when is this big meltdown supposed to happen? If everything that has happened already this year didnt even phase the Dow… whats left?<<< The market is in a "it doesn't matter till it does" stage. Just like up to May of this year, the backdrop for earnings was weakening and stocks were climbing despite high energy prices, etc. Same thing is happening now. Also, you have a huge sigh of relief slow creep up in the market after the horrendous oversold indicators in May-June. So...things don't matter till they do. And we already saw how fast the market can react when it wants to.
Why is it the bulls can talk up a summer rally out of thin air most anytime and when us bears start speaking of a 4 year cycle low or such, the trade becomes crowded?
per Mike L:
“severe oversold conditions?? the Dow is 300 points away from all time highs again.. several indexes continue to make all time highs even today $CMR.x $UTY $XTC $DRG
something has been missed.. and dont tell me i’m not bearish.. I’m short the YM and long DXD.”
Seems to me that you need to focus on reading what was written as you back out of trading altogether since you apparently are invested in something called “YM” that doesn’t appear to exist and have a patience fuse of about 2 hours
This is not day trader stuff, it is macro, and if you want to make money, you give it room to breathe. That means act like an adult and expect drawdowns when they come, otherwise find something else to do with the money.
Ideally, you would use leverage to pump every cent that you’ve got x 2 into $SPX. I beg you to do that.
nice one whipsaw
One other point “behind the earnings #’s” was revealed in H&R Block’s big earnings miss, related to a heffty repurchase of their MBS.
The Tax preparer’s are in the Mtg Business…
The car makers are in the Mtg bus…
The big Industrial conglomerates are in the Mtg…
Easy there Whipsaw. YM is the Dow-mini sized futures. I would assume the DXD is probably the Dax futures. I stopped trading the futures when I moved up here because of data feed issues, but used to only trade the YM and ES back when I was “capital challenged” (aka poor). It’s about the only solution if you want to daytrade and don’t have the 25k to avoid pattern day trader rule in equities.
About Barry’s excluding energy in considering the validity of earnings. You can have it both ways. It depends on what you are trying to analyze.
Earnings that go to energy companies act as a drag on the economy. The oil price spikes of 1973-74 killed the economy. Earnings that go to Tech companies such as Cisco in order to upgrade routers increase the productivity of the economy.
iteresting post and information , quite argualable in consept “external economic activity”, and its special feature over the organizational- lawful conditions to divert profits, services of the sales side of the Firm and structure of commodity markets…
The actual question about the profits reverting… and the whole flow of profits seems to be troublesome, may be it is a time to go back to the principles of capitailsm …}}} Explanations and some of the comments are more of a wishfull thinking rather then actual understanding.