What comes next should be no surprise to anyone. What we have been discussing for the better part of 2011: namely that this year is a spitting image of 2010, to the debt ceiling debate, to the Q1 market spike and subsequent drop, to an insolvent Europe, to the various allegations of bank impropriety, to the debt monetization, and pretty much to the dot, is captured best by SocGen's Albert Edwards who shows that various leading indicators have now rolled over, and absent some "exogenous" push (wink wink Chairsatan), the rollover now, just like a year ago, means the fun for the Hamptons crew is over for now, absent some very heated discussions between Hatzius and Dudley at the Pound and Pence.
From Albert Edwards:
Durable goods orders posted a better-than-expected 2.9% rise in March as did ?core? orders ? excluding the volatile defense and aircraft components. Yet despite March?s strength, both the yoy and sixmonth change in core orders has slowed sharply in recent months (see left-hand chart below).
Why might capital goods orders be slowing at exactly the point in the cycle when most commentators expect it to be making a greater contribution to overall growth? Well, contrary to most of the hype we are hearing in this reporting round, profits have not been doing so well recently (for a fuller explanation of this most recent spate of report round earnings manipulation, please contact my colleague, Andrew Lapthorne).
Economists tend to look at national accounts measures of profits which, to the surprise of many, often tend to lead stockmarket profits. The right-hand chart above shows that the surge in profits from their nadir has actually flattened out over the last six months (we have always preferred to use pre-tax domestic non-financial profits with inventory profits removed and depreciation put on an economic rather than a tax basis). Although the rate of profitability remains high, it is the growth of profits that tends to be the largest determinate of investment growth. So the slowdown in capital goods orders makes total sense in this context.
The level of analyst optimism also seems to be turning down (albeit from high levels ? red line in chart below) and the change in optimism, which we show on the front cover to be a good leading indicator has also thus fallen away (dotted line in chart below).
With valuation unattractive and now EPS momentum slowing (even before QE2 ends), this is the point in the cycle when investors should be becoming more cautious (see chart below).