Guest Post: Change In Corporate Profits Leads To Market Movements

Tyler Durden's picture

Submitted by Lance Roberts of StreetTalk Advisors

Change In Corporate Profits Leads To Market Movements

Part 1

 

Change In Corporate Profits Leads To Market Movements

Lately
analysts have been stumbling all over themselves to raise estimates for
earnings growth over the coming quarters based on recent earnings
announcements by various companies.   However, one of the things that
should be paid attention to, besides rising input prices and weakening
economic variables, is the Year Over Year Change (YOY %) in corporate
profit margins.

The BEA released the latest corporate profit figures today stating: 
"Corporate profits in the first quarter expanded to $1.450 trillion
annualized-up from $1.369 trillion in the fourth quarter. Profits in
the first quarter were up an annualized 25.6 percent, following a 12.6
percent drop the quarter before. Profits are after tax but without
inventory valuation and capital consumption adjustments. Corporate
profits are up 5.8 percent on a year-on-year basis, compared to up 11.4
percent in the fourth quarter."

The key to note here is the decline of the YOY rate of growth in
profits.   It has markedly declined since the peak in 2010 which
historically is a good signal that we are near a market top as stocks
are currently pricing in earnings and economic perfection.  Of course,
as we have warned in the past, it only takes a small stumble for stocks
to return to fair market valuation quickly.  

Currently, the market is ignoring the decline in YOY corporate
profitability due to the massive amounts of artificial stimulus and most
of the mainstream media is still trying to put out positive spins on
slowing economic growth.  Just as a reminder in December of 2007, when
the media was still touting that  "subprime was contained" and we would
have a "soft landing in the economy", we stated that "...we are currently in or about to be in a recession."   Then in March of 2008, as the media was proclaiming that we would have a "goldilocks economy" - we stated that "...we are about to be in the worst recession since the Great Depression." 
The evidence was much clearer then and there wasn't the invisible hand
of the government supporting virtually every sector of the economy.   

Therefore, while it is currently unclear whether "QE 3 to Infinity"
will continue to support a flailing economic recovery or whether there
is true organic recovery embedded in the bowels of the economy; it is
clear is that the decline in corporate profits is something that should
be paid attention to.    The markets always overshoot on the upside and
the downside and stocks are currently priced for economic perfection
that simply does not seem to be in the cards.

Remember - it is always easier to make up a lost investment opportunity than lost capital.

Part 2

 

Slide In Corporate Profits - Part II

Yesterday we posted a piece on the recent slide in the Year-Over-Year change in corporate profits as compared to the S&P 500.  
During a discussion with my friend Tyler Durden at Zero Hedge, Tyler
gave me the brilliant suggestion to also compare the change in corporate
profits to both the change in economic growth as well as jobless
claims.

Tyler's insight was right on track as show in the chart.   When
corporate profits are overlaid against an inverted scale of jobless
claims we find a very high correlation.   What might be the explanation
of this?   As corporations get lean during a recessionary period
profitability rises due to layoffs and cost cutting.   Remember - the
two biggest expenses to companies are healthcare benefits and labor
costs.   When they layoff employees those costs drop straight to the net
income line.   However, since the peak in corporate profits - companies
have been slowing hiring again, unfortunately not to great degree, but
enough to begin impacting profitability.  

Secondly, when looking at profits compared to GDP we find, again,
another very high correlation.  With the economy weakening and consumer
spending declining due to lack of wage growth, and now a decline in
government support as well, it is not surprising to see a decline in
corporate profit growth.   With the consumer making up 70% of the
current economic growth rate through consumption any impact on the
consumer is going to quickly filter through to corporate profitability,
and as we showed yesterday, stock market prices.

Finally, the evidence is mounting that corporate profits are under
attack due to rising input costs through high commodity prices,
weakening support from the consumer and an overall weakening state of
manufacturing and employment completing the feedback loop into the
domestic economy.    While economists are still predicting just a
slowdown in the economy before a reacceleration - my thoughts, as stated
before, is that we will either see close to zero economic growth by the
end of the summer or QE 3.