Weekly Chartology: Unusually Uncertain Outlook And Midterm Mayhem
In this week's chartology from David Kostin, the Goldman strategist focuses on two key topics most pertinent to his client discussions: (1) The path of the US economy; and (2) whether profit margins will continue to establish new record highs. Kostin summarizes the divergence in views on the record corporate profitability (the micro bullish indicator) as follows: "No common ground exists regarding the outlook for profit margins. Bulls argue that further productivity gains will allow firms to drive margins higher to a succession of new record levels. Supporting evidence is that firms are not hiring (at least not in the US) so unemployment will stay high and the Fed will not raise rates, allowing firms to continue re-financing debt at low interest rates. Bears counter that weak top-line sales growth makes it difficult for firms to boost margins. Price hikes are impossible as the lack of job creation means wage growth is stagnant. A weak US Dollar (viewed by most clients as a secular trend) would help margins but only 30% of aggregate revenues for S&P 500 is sourced abroad and for the median firm the ratio is just 25%. Margins for emerging market operations are often lower than the overall company average." As for the macro picture: forget about it - as the Goldman macro team has noted numerous times, the economy is sliding, and only a last minute intervention from the Fed in precisely one month can help.
Kostin also devotes space to the implications of the mid-term election on stocks.
The mid-term election is just 32 days away (November 2nd). Historically, it has marked an inflection point with the S&P 500 recording positive gains during the 12 months after each of the 15 mid-term elections since 1950. Appreciation averaged 18.1% during the first year following the election, with a minimum gain of 3% and a maximum gain of 33% (see Exhibit 1). All elections have consequences, but the stakes seem especially high this cycle. According to RealClearPolitics.com, an independent political web site that aggregates the latest polling data, Republicans seem likely to gain control of the US House of Representatives while Democrats appear likely to retain their majority in the US Senate. Polls as of October 1, 2010 show 207 seats in the House of representatives as safe or leaning Republican, 190 seats as safe or leaning Democratic, with 38 seats considered “toss ups.” Majority in the 435-seat House requires 218 votes and 37 of the 38 toss-up seats are currently held by Democrats. RealClearPolitics.com shows 48 seats in the US Senate as safely Democratic or not up for election (including 2 independents who caucus with the Democrats), 46 seats as safely Republican or not up, with 6 seats considered “toss-ups.” All six “toss-up” seats are currently held by Democrats. A change of control election in the House and/or Senate has generally been associated with positive returns during the subsequent 12 months. The results of the mid-term election will have important implications for the business and regulatory environment in the US during the next two years.
So now the next big meme will be the run up following the mid-terms, since the massive surge of the market into the midterm elections to new all year highs did not quite materialize. Also, on Exhibit 1 below, whgre does the chart suggest a 10% rise in the market two months ahead of elections? In fact, the average reading suggests a drop in stocks in the 2-3 months before mid-terms. In other words, timing mid-terms is yet another completely irrelevant data point, and the only thing that continues to matter is Ben Bernanke's "middle-class destruction" world tour.