With the S&P 500 on track for an 11% gain in Q1, and the foundations of global growth (China?), and European tail-risk (back in a big way) now off the table; it would appear that the asset-getherers are falling back to 'earnings' as the meme-du-jour. Despite the now more-than-anecdotal evidence from several major bellwether stocks, faith is strong that margins will expand...
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and the "mother's milk' of stocks will flow.
Miracle 1 and 2
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- in the face of
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However, it appears in reality that things are a little different; as we noted here [8], actual margins have fallen to Q1 2010 levels (even as expectations soar) and with labor costs rising (and Okun's law broken [9]), the following chart should make it extremely clear just where the pain will have to come from to confirm the 'hope'.
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US firms have been slashing labor costs for a decade and it appears they have hit a self-destructing wall as sentiment, spending, and employment gang up to ruin the party - no matter how hard the government tries to fund the great rotation from employment to benefits.
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Via Gerard Minack of Morgan Stanley,
To the extent that margins have been assisted by fiscal easing, the significant fiscal tightening now being introduced suggests that the gap between US-sourced and foreign-sourced earnings may narrow in coming quarters.
Two forward-looking issues: First, how much further can markets rally solely on the basis that the world is normal? When will investors need to see positives – not just diminished negatives – or can loose money drive further PE expansion? Markets outside the US have now stalled, suggesting we may be at that point. Second, what will it take for investors to realize that the world is not normal? It may be that Cyprus, or US macro weakness, will cause at least a tactical setback.
So it seems that with global investors now well aware that China is going nowhere, and Europe at the edge of a cliff again, the global central bank bath of dirty water has slooshed back to the US - but the point of this brief artucle is - earnings, margins, and thus valuations at some point will force that 'money' to slosh back to other end of the bath (as we see with Treasury yields pushing lows once again)
Source: Morgan Stanley