Earnings Season Set To Disappoint
With the market already under pressure from a significant economic slowdown in China, a recession across much of the Euro-zone, a concern that Japan's "Abe-nomics" experiment may not succeed and a message from the Federal Reserve that the "punch bowl" is set to be taken away - stocks, and bonds have come under tremendous pressure.
Jeff Cox, CNBC, wrote this morning:
Companies haven't even started posting second-quarter earnings results yet, but the early picture isn't pretty. The pre-earnings season is often referred to by market insiders as the "confessional"—that time when Corporate America starts letting shareholders know the truth between earnings perception and reality.
If this quarter's version is a reliable indicator, there will be some serious penance handed out once announcements officially begin in two weeks. Earnings pre-announcements have been decidedly ugly, running about 7 to 1 negative to positive.
That's the worst level since the first quarter of 2009, when, in the words of Citigroup chief strategist Tobias Levkovich, 'the global economy was sitting on the edge of the abyss undergoing a financial crisis and near systemic meltdown.'"
He is correct in his analysis as shown in the chart below from a recent article by Alexander Kaufman of International Business Times:
As I have discussed recently the sell-off in the market most likely has less to do with Fed "tapering" and is more about what is happening fundamentally in the markets, and economy, both domestically and internationally.
"The economy is currently pushing a third straight quarter of sub-2% growth with the Federal Reserve discussing taking away a major support for the economy. The extraction of liquidity from the system will stem the forward pull of future consumption, which has come at the expense of higher credit balances and lower personal savings rates for consumers, leading to weaker rates of economic growth.
With corporate earnings dependent on consumer spending (70% of GDP) the gap between economic realities and financial fantasy will likely be filled sooner, if the economy continues to weaken.
The weak economic story, combined with weakening fundamentals and extreme price overvaluation will ultimately lead to a correction of some magnitude in the market. This will occur regardless of whether the Federal Reserve "tapers" their intervention program or not. This leaves investors at the whims of a highly leveraged market that has become much more volatile in recent years. Investors have piled into some of the riskiest assets in the market in their quest for income as their faith has been placed in the Fed that they will prevent a market meltdown. Maybe that is the case, however, history suggests that such blind faith in the markets has rarely worked out well in the long run."
We have long discussed the implications of continued artificial interventions into the markets and economy. While such liquidity programs have continued to inflate asset prices they have done little to restore real organic economic growth which has translated into lower revenue growth. The biggest boost to profitability has come at the expense of employment to boost profitability. That ability has likely now come to an end and weak demand is showing up in the bottom line.
The real impact of these negative pre-announcements on the markets will be the reversion of "fantasy" to "reality". While analysts continue to expect earnings to soar to all-time new heights, as shown in the chart below, it is unlikely to be case.
The potential issue is that globally these intervention programs are retarding economic growth and it is coming home to roost in corporate profitability. The slate of negative pre-announcements is likely to continue as the global economic weakness weighs on the exports of domestic companies which makes up as much as 40% of revenue for S&P 500 companies.
Currently, there are virtually no "bullish" arguments that will withstand real scrutiny rather is is yield spreads, the "Fed Model" or valuations. The reality is that with the global economies teetering on the bring of depressions it is only a question of whether, or not, the domestic economy can withstand being dragged into a recession along with them. While Bernanke may talk about potentially "tapering" bond buying in the future; it is likely that such reductions in artificial supports will not be because of renewed economic prosperity - but rather due to the realization that such programs have become a detriment to economic health.