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Hussman Shows Why Record Corporate Profitability Portends Weakness Ahead
One of the key forward looking topics that so far relatively few wish to touch, is what the implications of record excess money sloshing around will mean for corporate margins. Following the past 3-4 quarters, in which corporate profitability has risen to near all time highs, surging input costs threaten to end the party short, as companies such as Dean Foods demonstrate they have little ability to pass prices through to consumers (nonetheless, they will certainly have to try eventually). But Fed aside, is there a cyclical relationship between the vagaries of the corporate profitability cycle, and broader economic growth? As John Hussman demonstrates in his most recent note, The Cliff, this is indeed the case, as "present levels of corporate profits are followed by negative profit growth over the coming 5 years." Which is why all those calling for margin expansion and S&P EPS growth may wish to reconsider: being wrong about one of the two is bad, being wrong about both means one better be a TBTF...
From John Hussman:
I've reviewed the valuation conditions of the stock market extensively in recent months, emphasizing that stocks are not a claim on a single year's earnings, but rather on a whole stream of future cash flows that will be delivered to investors over time. At present, investors and analysts who focus on simple price/earnings multiples (rather than modeling the entire stream of cash flows) are placing themselves at tremendous risk, because simple P/E multiples are being distorted by unusually wide profit margins. Part of this can be traced to weak employment conditions, which have held down wages and salaries. But there is more to the story - the rebound in profit margins also reflects a heavy contribution from financials (which may be more indicative of accounting factors than sustainable earnings), as well as the tail-end of stimulus spending.
The chart below underscores the relationship between high current profit margins and poor subsequent earnings growth. The blue line shows U.S. corporate profits as a percentage of GDP (left scale), which is currently just over 8% and at the highest level since 2007. The red line depicts subsequent 5-year growth in profits, but on an inverted right scale (higher values are more negative). In effect, it should not be a surprise if present levels of corporate profits are followed by negative profit growth over the coming 5 years. Indeed, the 2009 burst of stimulus spending is most probably the only factor that has prevented profit growth from being negative over the most recent 5-year period.
Municipal bond investors are clearly re-evaluating the prospects for additional fiscal stimulus from the federal government. Indeed, many state and local governments (as well as health and disability service providers that benefited from stimulus dollars), are beginning to talk about "the cliff" - an abrupt reduction in revenues due to the loss of current stimulus funding which has been used to bridge existing budget shortfalls. My impression is that equity investors face a similar "cliff" which they may not have adequately recognized yet.
The essential point is that stocks are much more richly valued than simplistic P/E multiples would suggest. Investors may pay a heavy price if they fail to adjust valuations for the level of profit margins. The only proper way to value stocks is in relation to measures of sustainable, long-run, full-cycle financial performance.
Full note, with many more relevant insights, here.
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reality comes home
Now this supposition really is a stretch
Ya, and there is no one friendly to business in the administration...
Could make sense except there is no thesis outlining why corporate profit margins cannot be sustained, ie, cost pressures and lack of pricing power in a high unemployment world? That seems to be a large risk right now but if the jobs picture gains momentum then the ability to pass along cost increases improves.
Cost pressures may be passed thru and gross margins may increase, but your operating expenses will likely increase if we do see increasing employment. First, just from adding people and their salaries, second from those who start to look for new jobs and force employers to pay higher wages and increased hours. I think that leads to declining net margins.
You can either price in expanding SG&A margins and declining NI margins leading you to say stocks are overpriced. Or you can price in another credit crisis environment where stocks collapse. I think, either way, stocks are probably overpriced at this point. Trying to be short may be a losing position, but investing in stocks at these prices is probably just as negative.
I wrote about this in my 2010 forecast. I suspect a wicked decline in profit as a % of GDP that will take S&P to 380 by 2012. I thought we'd see decline already and S&P would be as low as 780 by year end. Whoops.
Well the year hasnt ended yet, and a lot can still happen. Just 1 nuke landing in a large east coast city can suddenly mess the plans of even the biggest TBTF's.
"worthless greenback...worthless greenback...worthless greenback..."--how does one "drive the bus" around that "pothole"?
More blindfolds for the bus driver and occupants.
Possibility that a credit crisis in Europe and loss of confidence in Chinese "growth" means that people flock to the dollar, the only "safe" asset they see. Just like in 2008
How about another line on the graph:
Deviation from GAAP.
......true dat. GAAP can't get much more deviant than it is today.
ask CSCO about the cliff...
Hussman's views are interesting, but are posted on his MUTUAL FUND website.
I see no reason why they have to be regurgitated here.
Bringing attention to authors others may not be familar with is one of the points of this blog I believe.
"nothing a little extra fuel can't cure" either I guess.
Also it must be nice to report fields of green shoots earnings and profits when theyve all been given a license to cook the books. The whole damn thing is ust an illusion, waste of time trying to analyze the numbers in a rigged game.
And another thing everyone keeps forgetting is theyve chased away the retail investor from this crooked market casino forever. Pump all you want, theres no one to sell to.
Revenues are not growing in historic proportionality as earnings, which have been rising through lay-offs, lower wages and other cost cutting factors.
Lack of revenue growth will not support GDP growth of at least 3% that is necessary for lowering unemployment.
Stimulus money, like much of traditonal medicine, does nothing to get at the systemic basic math problem of:
After wages and jobs are cut to the max, margins cannot be squeezed anymore, and municapalities need more subsidies than the govermnent can provide to pay teachers, firemen, police etc..., what then? Not to mention rising energy costs which are inversely related to GDP growth.
Same as them reporting retails sales way up, in the face of retail sales tax revenue being way down. If anyone is dumb enough to believe any of it and 'buy the dip' or whatever, well good luck to them then they'll need it.
Chart: ES and ZB
Before POMO...
http://99ercharts.blogspot.com/2010/11/es-zb_15.html
http://www.zerohedge.com/forum/99er-charts
Oh, that's why they're selling off at N,000:1...
Hussman's reference to Dean Foods was something I mentioned here last week. It's one of a growing list of companies in the midst of a margin squeeze due to ever rising input costs combined with ever tumbling demand due to a constrained consumer. The biflationary forces in the economy led me to predict this for over a year, and it's now firmly taking hold.
On a macro level the NYS Fed Survey this morning and last month's Philly Fed also reflected this vice grip. These are leading indicators because they reflect what's happening on the ground and in the trenches with companies of all sizes, not just the large headline grabbers. Of course small business, one of the major drivers of the US economy, is under the most pressure and is the least reported.
Not sure if someone can pull up a chart which shows the decline of dividend issuance across a broad range of companies.
I think you will be charting the perfect line of the collective decline.
In the US that is.
Weak boards and complacent shareholders, happy to get their returns through the market, ensured the trend would catch.
Now it has, and the bite is in and it's painful.
What a masterstroke by the "CORPORATION".
ORI
http://aadivaahan.wordpress.com
Please continue to "regurgitate" his comments (even though I read them every sunday anyway). I think the guy's brilliant. Page 3 (section entitled Singularity) is a perfect description of the absurdities perpetrated by the Fed and Congress today.