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Corporate Profits Vaporizing
Submitted by Jim Quinn via The Burning Platform blog,
Hussman has some more brilliant insights this week, which most people will ignore, because we all know he is a perma-bear who only cites facts and historical data to prove how overvalued the stock market is at this point in history. Why should we pay attention to his fact based analysis when the market is up 250 points today? But, in case someone is interested, I’ve picked out the key paragraphs from his weekly letter and I’ve bolded the sentences that make the most important points.
Hussman explains how corporations have been able to maintain record level profit margins. They’ve done it on the backs of taxpayers and the working class. The government transfers and increase in consumer debt (student loans & auto loans) have filled the gap of pitiful wage gains and kept corporate profits at record levels. Thank you Ben, Janet, Obama and a feckless Congress.
Elevated corporate profits since 2009 have largely reflected mirror image deficits in the household and government sectors, as households have taken on debt to maintain consumption despite historically low wages as a share of GDP, and government transfer payments have expanded to fill the gap, with 46 million Americans now on food stamps – a five-fold increase in expenditures since 2000. Essentially, corporations are selling the same volume of output, but paying a smaller share in wages, with deficits in the household and government sectors bridging the gap. As households and government have shoveled themselves further into the hole, corporate profits have climbed higher on the adjacent pile of earth. Deficits of one sector emerge as the surplus of another.
One problem with this scenario. Corporate profit margins always revert back to the long-term mean. The debt based profit bonanza is going into reverse. The strong dollar, increased consumer saving, less entitlement transfers (food stamps, extended unemployment) and continued pitiful real wage growth are combining to take the legs out of the ladder of corporate profits.
In short, corporate profits expand when gross domestic investment is growing strongly, the U.S. current account balance moves toward surplus (more exports, fewer imports), and the sum of household and government savings deteriorates. At present, all of these components are moving in the wrong direction from the standpoint of profit margins. Yet none of these components have moved so far that we would expect that direction to reverse. That’s another way of saying that the ladder that has supported the move to record high U.S. corporate profit margins is beginning to snap. It may be a long way down.
Corporate profits are falling while valuations are at record levels, on par with 1929, 2000, and 2007. Every reliable long-term valuation method reveals the market to be at least 100% overvalued. A Millennial entering the workforce today and investing in the company 401k will likely see the S&P 500 at the same level when they are almost 50 years old as it is today.
Though it’s not widely recognized, measures such as the ratio of market capitalization/nominal GDP and the S&P 500 price/revenue ratio are actually better correlated with actual subsequent total market returns than price/operating earnings ratios, the Fed model, and even the raw Shiller P/E (though the Shiller P/E does quite well once one adjusts for the embedded profit margin). To fully understand the present valuation extreme, recognize that the market cap/GDP ratio is currently about 1.29 versus a pre-bubble norm of just 0.55, with “secular” lows such as 1982 taking the ratio to about 0.33. To fully understand the present valuation extreme, recognize that the S&P 500 price/revenue ratio is currently about 1.80, versus a pre-bubble norm of just 0.8, with “secular” lows taking the ratio to about 0.45.
To put these figures in perspective, if we assume that nominal GDP and corporate revenues will grow perpetually at a 6% nominal rate (which is much faster than we actually observe here), and the market does not experience another secular market low until 2040 – a quarter century from now, the S&P 500 Index would still be approximately unchanged from current levels at that secular low 25 years from today.
But at least you have bonds providing negative real returns across the world. Who wouldn’t want to loan fiscally irresponsible governments run by corrupt politicians and captured central bankers trillions of dollars and you pay them for the privilege of doing so?
One obtains less extreme conclusions, though still uncomfortable, if one assumes that these multiples simply touch their pre-bubble norms a decade from now. In that case, the annual percentage change in the S&P 500 Index over the coming decade would be -2.67% and -2.26%, respectively. If all of this seems preposterous, keep in mind that these revolting long-term prospective returns in stocks are simply a less recognized variant of what we observe more clearly in the bond market, where long-term interest rates are now negative in about one third of the developed world. Investors are literally paying their governments for the privilege of lending to them on a 5-10 year horizon. Investors are collectively out of their minds if they believe that current equity prices don’t quietly reflect the same absurd state of affairs.
In addition to falling corporate profits, obscene overvaluation, and a consumer barely getting by, the economic data for the last three months has been atrocious and continues to worsen by the day. The Atlanta Fed is already showing negative real GDP for the first quarter. Increased consumer spending on Obamacare and food is not a recipe for economic success. The data below proves we are in a recession.
The following chart captures some of our concerns on this front. Manufacturers new orders are now contracting at the fastest rate since the past two recessions. We don’t believe there’s enough evidence to warn of a recession at present, but the data are clearly going in the wrong direction.
We also observe an abrupt contraction in new orders for consumer goods here, shown in the chart below.
I updated our own composite of economic conditions a few weeks ago. The chart below presents a similar index called the ADS Business Conditions Index (h/t the always resourceful Doug Short). While current levels have sometimes been observed outside of recession, our concern again is the abrupt deterioration, and the fact that the data are clearly moving the wrong way.
Today is one of the worst times in the history of the country to be invested in the stock market, bond market, or real estate market. You can ignore the facts, but that doesn’t make them not true. If you believe this is a great time to invest in stocks, you should borrow on margin and buy some Netflix. What could possibly go wrong?
Presently, we observe obscene valuations coupled with evidence of a shift toward increasing risk-aversion among investors. For that reason, I continue to believe that the present moment will likely be remembered among a small handful of the very worst points in history to invest in equities from the standpoint of prospective return and risk.
I can’t overstate that whatever a defensive investor might have “missed” in the late stages of the tech bubble, or the housing bubble, the 2000-2002 decline wiped out the entire total return of the S&P 500 – in excess of Treasury bills – all the way back to May 1996. The 2007-2009 decline wiped out the entire total return of the S&P 500 – in excess of Treasury bills – all the way back to June 1995. The intervening market gains didn’t mean a thing for investors who didn’t act at points of severe overvaluation to realize those gains. Doing so might have been frustrating over the near-term, but the completion of each cycle was ultimately very forgiving about exactly when an investor might have acted, particularly if the defensive action was at a point of market strength and overvaluation.
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Profits? We don't need no stinkin' profits!
as long as we can borrow at .1%, so we can buy the shares back from our execs at ridiculously high levels......the ponzi will sustain.
This ends when all public companies have bought back all but one share of their own outstanding stock. There will be two guys left who trade that share back and forth between themselves a million times a day, spoofing eachother's trading algorithms and skimming a trillionth of a penny per trade.
In a NIRP world profits will cost you dearly.. BTFD the underwater ones, thats where I sense the future profits!
What was that cheese truck called again?
Those FRED charts are as of Feb 1
The March data points should be a lot lower
Obama is clearly on target to get those pesky CO2 emmissions down...
"What was that cheese truck called again?"
The Cheese Pope-mobile
This ends when all public companies have bought back all but one share of their own outstanding stock. There will be two guys left who trade that share back and forth between themselves a million times a day, spoofing eachother's trading algorithms and skimming a trillionth of a penny per trade.
Funniest thing i've read today.
I'm making over $7k a month working part time. I kept hearing other people tell me how much money they can make online so I decided to look into it. Well, it was all true and has totally changed my life. This is what I do... www.globe-report.com
The Fed is destroying the real economy, and capitalism itself, part 50.
I thought profits were derived from the Fed and that the Fed guv created all the new jobs??
Only Pinko Fascist Commies have brains that work like that.
Don't forget Treasury!
i remember an interview with geithner back in 2010 ... questionned about how to get economy growing ... response? ... get back to industrial roots? ... haha, the dope practically foaming at the mouth talking of spreading "financial services" across the globe.
I think you meant to say ""financial" "services"" (assuming I'm not still missing some quotes).
Time for the Elites to head for the hills (or their Billion dollar bunkers they built with all that TARP money)
They started leaving new year.Should be all cashed out around now.It takes a little
time to liquidate without moving the market.
Only pension funds and suckers are left in, but I repeat myself.
i had to laugh ... couple of months ago Tudor Jones spoke on class warfare coming ... and then a few weeks later it came out he purchased a $70+ million home in florida
Class warfare coming?
As if what's been happening the past thirty years hasn't been bad enough. He must mean the new plan where every citizen pays a flat tax of $20,000 per year.
One thing you won't find here is defensive investors. Dude we know how to BTFD.
I thought that WAS defensive investing.
Thats trading, not investing, and if you don't know the difference , you
should be doing neither.
Trading and investing are the same thing. Differing only in how long you plan on holding the security.
Hold for as long as 2 hours, maybe even longer under special situations: long term investing
Hold for 1 minute to 2 hours: short term investing
Hold for 2 milliseconds to 1 minute: trading
(You DO realize I'm pulling your leg, right?)
Too many act out your parody.
Never fear, black money is here!!!!!!!!!!!!!!!!!!!!!
And I'm not talking oil, unless it's being sold by criminals.
Don't' worry we have a war on the way. TPTB furiously working on a "catalysing event" as we speak.
another reason corporate profit growth hitting wall is interest rates pretty much rock bottom
a few years ago bloomberg had an article saying corporations had made an extra $700 billion in profit due to lower interest expense since recession (corps rolled over high interest debt into lower ... presto ... more loot for execs and stockholders ... at expense of fixed income debt holders, of course)
Check out that recent channel stuffing on the manufacturers side which recently said oh shit and started falling again... Oooooops
Sorry John - but this time is different. The central banks will never stop trying to drive this bubble higher. So trying to time this is pointless because:
1. You will never know when the pushing on a string phase begins
2. And even if you did get lucky and time it this bubble is exponentially larger than 2008 and when it blows all bets are off --- this is going to explode the global economy and end civilization.
So yes, this time is different. Civilization was built on cheaply extractable oil - that era is over -- therefore civilization is about to end
THE END OF CHEAP OIL Global production of conventional oil will begin to decline sooner than most people think, probably within 10 years
Feb 14, 1998 |By Colin J. Campbell and Jean H. Laherrre http://www.scientificamerican.com/article/the-end-of-cheap-oil/
HOW HIGH OIL PRICES WILL PERMANENTLY CAP ECONOMIC GROWTH For most of the last century, cheap oil powered global economic growth. But in the last decade, the price of oil has quadrupled, and that shift will permanently shackle the growth potential of the world’s economies. http://www.bloomberg.com/news/articles/2012-09-23/how-high-oil-prices-will-permanently-cap-economic-growth
HIGH PRICED OIL DESTROYS GROWTH
According to the OECD Economics Department and the International Monetary Fund Research Department, a sustained $10 per barrel increase in oil prices from $25 to $35 would result in the OECD as a whole losing 0.4% of GDP in the first and second years of higher prices. http://www.iea.org/textbase/npsum/high_oil04sum.pdf
BUT WE NEED HIGH OIL PRICES: The marginal cost of the 50 largest oil and gas producers globally increased to US$92/bbl in 2011, an increase of 11% y-o-y and in-line with historical average CAGR growth. http://ftalphaville.ft.com/2012/05/02/983171/marginal-oil-production-costs-are-heading-towards-100barrel/
Steven Kopits from Douglas-Westwood said the productivity of new capital spending has fallen by a factor of five since 2000. “The vast majority of public oil and gas companies require oil prices of over $100 to achieve positive free cash flow under current capex and dividend programmes. Nearly half of the industry needs more than $120,” he said http://www.telegraph.co.uk/finance/newsbysector/energy/oilandgas/11024845/Oil-and-gas-company-debt-soars-to-danger-levels-to-cover-shortfall-in-cash.html
THE PERFECT STORM (see p. 59 onwards)
The economy is a surplus energy equation, not a monetary one, and growth in output (and in the global population) since the Industrial Revolution has resulted from the harnessing of ever-greater quantities of energy. But the critical relationship between energy production and the energy cost of extraction is now deteriorating so rapidly that the economy as we have known it for more than two centuries is beginning to unravel. http://ftalphaville.ft.com/files/2013/01/Perfect-Storm-LR.pdf
Thanks for reposting for those that didn't see it first time.
TPTB need a 90% depopulation event, and that exposes the motive for all to see.
To your point on mal investment oil and gas in USA posted Naked Capitalism:
http://www.nakedcapitalism.com/2015/04/saudi-arabia-really-targeting-price-war.html
Mr. Kibsgaard shows Schlumberger’s assessment of drilling intensity or efficiency. For nearly equal oil-production volumes of about 11 million barrels per day, U.S. oil producers drilled more than 35,000 wells and 297 million feet of hole compared to 399 wells and 3 million feet of hole for Saudi Arabia. Russia drilled 8,688 wells for equivalent production.
U.S. companies drilled almost 100 times more wells to reach the same daily production as Saudi Aramco. Strident claims of increased efficiency by tight oil producers sound absurd in this context.
This suggests the market share of US - absent ZIRP for capital - is going elsewhere
Been visiting ZH for years. There's a bias towards bearishness that I feel is warranted. But the markets keep going up. Must be rigged. Will this ever end?
If I had ten or twenty friends fly back from vegas and tell me they all won 30,000 dollars, and everyone they knew won 30,000 dollars, I would assume that something was seriously wrong and that eventually they would receive a knock on the door from the FBI, or worse, wanting their money back.
There's no way I'm getting on a plane and flying out there to try and cash in. If something's too good to be true, it is.
Profits??? The Progressives only like and recognize non-profits where there never is any wealth created outside of the salaries for the top guys like the "Clinton Global Initiative Foundation". See they are then altruistic, all for profit corporations are simply greedy.
to Pol pot's plant. In the corridors of power they don't like words such as 'rigging' and 'fudging''. I have it on good authority that they use the term 'intellectual phase locking'