As Good As It Gets
While the impact of the Fiscal Cliff remains front-and-center in everyone's mind, SocGen's Albert Edwards has another, more prescient, insight into why stocks are reverting. In his words, "commentators are worrying about an impending fiscal cliff, we have actually already stepped off the profits cliff." As we noted last week, the divergence between markets and macro suggest a rather ghastly echo of 2008; as the market is falling in line with the dismal outlook for profits (rather than the more upbeat macro economic data). As far as the latter, we are getting close to a cyclical peak - so macro surprises are 'as good as it gets' - and for the former (earnings outlooks), Edwards shows an unprecedented level of optimism about EPS going forward. As we proceed into the new year, Edwards expects "the combination of poor profits and poor economic data to prove toxic."
Via SocGen's Albert Edwards:
Top Down, Edwards has concerns that we have 'topped out' in terms of economic surprise, and along with our views from last week, he also notes:
The resilience of the global equity market in recent months has been, in very large part, down to better than expected US economic data. The widely cited Citigroup Economic Surprise Index recovered from its nadir in late July and has been surging ever since. Together with the intoxicating vapours of QE3, the better than expected economic data helped drive the S&P to its mid-September 1475 peak.
But, despite the economic data continuing to surprise on the upside, the equity market has started to slide sharply lower. And, although renewed worries about the fiscal cliff have resurfaced in the wake of the Presidential Election, the S&P was in clear trouble two weeks before the election, when on 22 October it broke decisively out of its H2 up channel.
the bottom line is: despite the upside economic surprises, profits have been spiralling downwards. It's not the impending fiscal cliff the market is worrying about, it?s the actual profits cliff we have already fallen off.
My former boss, Roger Palmer, who brought me into this business in 1988, used to say “if the market can’t go up on ‘good’ news it will fall very sharply on ‘bad’ news”. It's all about expectations. The very prescient market commentator John Hussman regularly uses the chart below to demonstrate that economists optimism goes in waves - and for some curious reason that wave lasts about 44 weeks.
As we get towards the end of the year, the economic data will inevitably disappoint as we begin to slide down the sine curve.
Bottom-up things are also concerning. Edwards cites his colleague Andrew Lapthorne who notes:
"the outlook for earnings has been extremely poor in recent weeks. Yes, the US reporting season led to an improvement in near term (2012) earnings forecasts with the ratio of upgrades to total estimate changes for 2012 earnings rising from 44% to 50% over the past month, but earnings momentum for 2013 has slumped, dropping from 48% to 42%, leading to a major divergence between the two. For earnings momentum to collapse during a reporting season is highly unusual, as optimistic forecasts are generally reeled in over the period between reporting seasons."
and goes on...
"The question is not the level of earnings growth, but the rate at which earnings are being downgraded, and currently with global earnings momentum down in the low forties, it suggests we are already in a profit recession."
As Edwards concludes:
Disappointing economic data AND falling profits. Now that IS a toxic mixture!