Last week was a wild ride for US equities, but you wouldn’t know it if all you were told was that the S&P fell 0.4%.
Another sub-50 ISM manufacturing print, a soft ADP report and the worst ISM services read in three years conspired with systematic flows to push stocks sharply lower on Tuesday and Wednesday, before expectations of a more accommodative Fed, a “Goldilocks” nonfarm payrolls report and a reversal of the same mechanical flows that contributed to the selloff, rescued markets into the weekend. Friday’s stick save wasn’t enough to avert a third consecutive weekly decline, though.
While the S&P is up more than 17% in 2019, the benchmark has gone essentially nowhere over the past 12 months.
Now, investors are staring down a decelerating economy, a Beltway brawl for the ages and a Q3 earnings season that’s expected to bring negative EPS growth.
For reference, consensus expects aggregate S&P 500 earnings will fall by 3% in the third quarter. That would make Q3 2019 the first quarter of negative EPS growth in since Q2 2016. As Goldman notes, ex-Energy, it would be the first YoY decline in earnings since Q2 2009.
(Goldman)
As a reminder, lower-than-expected effective tax rates helped corporate America dodge expected EPS declines in Q1 and Q2. That “luck” almost surely ran out this quarter – just ask ISM manufacturing.
“The ISM index averaged 49.4 during 3Q”, Goldman wrote, on Friday evening, adding that “of the 26 quarters since 1990 when the ISM Manufacturing index has averaged below 50, the S&P 500 has posted negative year/year EPS growth 69% of the time”.
What accounts for expectations for EPS declines in Q3? Well, margin pressure. Specifically, Goldman notes that “excluding Financials and Utilities, S&P 500 margins are expected to contract by 108 bp, more than offsetting forecast sales growth of 5%”. As the following simple table shows, margins likely compressed in every sector last quarter.
(Goldman)
Unsurprisingly, earnings declines are expected to be concentrated in sectors with high exposure to international markets, including Energy, Info Tech and Materials – in other words, industries that are exposed to trade frictions and the worsening global growth slowdown.
In their July update, the IMF slashed its outlook for global growth for the fourth time in nine months. The fund sees the global economy expanding 3.2% in 2019, down from 3.3% in April and 3.5% in January. The outlook for 2020 was cut to 3.5% from 3.6% three months previous.
Similarly, the OECD recently cut their forecast for growth. In a September update, the organization said the global economy will expand just 2.9% this year and 3% in 2020. Those are the weakest annual growth rates since the crisis.
“Escalating trade conflicts are taking an increasing toll on confidence and investment, adding to policy uncertainty, aggravating risks in financial markets and endangering already weak growth prospects worldwide”, the OECD warned.
The good news for US corporate earnings is that the median company is still seen growing EPS by 3%, even as aggregate earnings decline. Goldman says it’s also possible that “tax rates may be lower than expected”.
As for Q4, the bank cites “upside and downside risks”. “While results are likely to be better next quarter than in 3Q given easier comparisons, estimates still look slightly optimistic, in our view”, Goldman cautions, adding that while “margins are forecast to expand for the median stock in five of eight sectors, including Industrials, Health Care and Materials, our economists forecast of stable economic growth, rising wages, and unresolved trade tensions suggests that sectors such as Industrials and Materials will continue to face margin headwinds”.
Looking out to 2020, Goldman is somewhat upbeat, although they warn that “many firms have been unable to keep pace with their input cost inflation” based on the NABE survey, a state of affairs that has, historically anyway, “been a precursor to EBIT margin declines”.
It goes without saying that more tariffs will not help the situation.
As far as anyone knows, tariffs on $250 billion in Chinese goods currently taxed at 25% are set to ratchet higher to 30% in less than two weeks. Then, on December 15, the Trump administration will slap an additional $160 billion in Chinese products with 15% levies.
SP500 at record highs when SP500 EPS growth is going negative – if this were a stock, that combination would make no sense unless rip-roaring earnings re-acceleration were expected, either next year (typical stock) or in a few years (high growth hope trade tech stock). Is SP500 EPS expected to grow 20% in 2020? Doubt it.
Low rates, buybacks, TINA and fear of trade deal are all supporting the SP500 in this weird situation.
I think the on-going earnings decline and stagnating GDP is a feature, not a bug — and oddly fits onto a mashed-up consolidated evolving theory that’s taking over my brain. Yesterday, there was a post on MMT here and of course, many blog posts about current troubles in the White House and various recession-like economic things and my obsession with the IOER-thing.
Mashed together in a blender, the resulting smoothy is to view our current economic situation as to be akin to a giant auto manufacturing entity/consortium, i.e., a massive complex global effort put forth by a massive amount of people, to produce an outcome that has positive benefits, but that effort essentially has to be realized in profitability.
Thus, the actions and policy choices of government entities and characters and their constituents are not too different from the workings and output of a corporation like Chrysler. Think about the vast armies of engineers and bureaucrats working like an engine, including a CEO with a vision and a treasurer who balances the check books — and of course the overall budget and planning for the future.
In a nutshell, the similarities in basic management structure can be thought of in terms of success and failure over time and thus compare the outcomes of various cyclical periods.
Therefore, when a company or administration has crappy policies and crappy people playing with designs, models and budget projections, the current and future value of management choices play out in economic terms which result in poor sales — causing dynamic cascading chains of events to unfold, sending the armies of engineers into accountability mode, in hopes of correcting compounding errors … and as Mr. Einstein said, you can’t fix stupid (you can’t solve a problem with the same kinda thinking that was used to create the problem).
So, the theory is, once you have really stupid people push all the wrong buttons on the super computer and feed-in too much idiotic bullshit and build really stupid cars, because some gangster family wants their kids to take part in the design and implementation of engineering – it’s highly likely that an idiot will produce really shitty thinking which results in a handful of other idiots agreeing with stupid shit — and ipso facto, like magic, we all end up looking at the results of stupidity and laughing at the emperor who walks around with his willy hanging out of his zipper ll day while he pretends to tweet shit that nobody understands, except his kids and all their sycophants.
In closing,here’s the winners in Edmunds worst cars of all time and a tribute to the parallel universe of crap cars and crap government:
1974 Ford Mustang II: Built upon the spindly bones of the Pinto, this shrunken, malformed pony is instantly appalling to Mustang lovers. Unfortunately, it was hugely popular with buyers stuck with serial fuel crises.
2001 Pontiac Aztek: It may be cliche, but it’s hard to argue with. Drive one and you quickly realize that the Aztek’s exterior design is its best feature. It’s the very worst car of all time because it’s the only car on the list to kill an 84-year-old car company. The Aztek drove the biggest and last nail into Pontiac’s plastic-clad coffin.