Thomson Reuters (This Week in Earnings, December 6, 2013) notes another New World Record. We are breaking plenty these days. This often foretells a Grand Finale. For the fourth quarter of 2013, 103 companies in the S&P 500 have announced negative earnings revisions. Only nine have disclosed positive profit assessments. The ratio of negative-to-positive, 11.4:1, exceeds the previous high (negative-to-positive ratio) of 6.8:1.
This is worth consideration. The 6.8:1 silver
medalist was during the first quarter of 2001. Early 2001 was unpleasant. More
importantly, for a ratio comparison, the unpleasantness was by then a
protracted, dismal bust, and was not news, except to Alan Greenspan, who
announced to the FOMC at its January 30-31, 2001, meeting that: "there is little evidence
of which I'm aware that long-term profit expectations have deteriorated to any
significant extent." A century from now, interested parties will need to
address the dilemma of who possessed the tinier minds: members of the FOMC or
the world that stood still in fear of its pronouncements, debating the layers
of analysis that never existed at the Fed prior to post-meeting announcements.
As a reminder of the moment: "By the end of 2000,
the Nasdaq Composite had fallen 51 percent and the Philadelphia Internet Index
had lost 77 percent from its peak. All told, investors in U.S. stocks had lost
trillions of dollars and were constantly reminded of this by the wonder of
technology's multicolored screens that flashed instant calculations of their
attenuated portfolio holdings." (Panderer
to Power, pgs. 235-236).
Announcements by companies of adjusted earnings predictions in a different
direction usually lag a sharp break (from recession to rebound, or its
opposite.) The first quarter 2001 reassessments were made by companies in the
midst of liquidation, most of which had accumulated during the boom: "On
December 4, 2000, Cisco Systems Chairman John Chambers delivered his annual
speech to Wall Street analysts. 'I have never been more optimistic about the
future of our industry as a whole, or of Cisco.' In January, Cisco Systems
announced the value of its inventory rose from $1.2 billion to $2.0 billion in
the previous quarter.Companies announced plans (or hopes) to reduce inventories
by the end of 2002. This unwinding across the whole economy would take years to
complete-unless some artificial paper printing inflated prices.... In April
2001, John Chambers admitted, "[T]his may be the fastest any industry our
size has decelerated." Chambers was paid $279 million in 1999 and 2000 for
his foresighted leadership." (Panderer to Power, pgs. 235, p.
237-238)
Since these moments of abrupt break are so easily forgotten, yet, so traumatic,
some more color: "Hewlett Packard was 'buffered by the slowing economy in
just about every segment of our business. Sales from dot.coms [are] essentially
zero.' Gateway's sales 'plummeted below already lowered estimates.' The CEO of
Nortel admitted, 'We now expect the U.S. market slowdown to continue well into
the fourth quarter of 2001.' Lucent's CEO warned, 'We have serious execution
problems,' after which, he immediately restored public confidence in his
execution acumen by firing 10,000 workers. Oracle's CFO made the
head-scratching admission, 'I haven't a clue what will happen,' and, 'We're
still trying to figure out what happened last quarter.'" (John Hancock
Quarterly Market Review, April 1, 2001. Thanks, Andrea)
So, what might we hear from CEO's in the first quarter of 2013? A schizophrenia
exists in which "we're in a bubble" is stated, even by some
central-banking bureaucrats. At the same time, the word from the Street is cheery.
The S&P 500, Dow, and Russell 2000 periodically post new highs; there
seems to be no concern (or knowledge) that 10-year Treasury yields have doubled
since before Bernanke's QEIII trillion-dollar, asset-buying commenced in the
fall of 2012. Corporate earnings as a percent of sales are the highest since
records were first collected in 1947. From the mouths of the Experts, this is a
good thing. So, why might we be on the verge of another first quarter 2001?
Stock prices are artificial. They have been lifted by central-bank asset buying
and the belief the Fed will not permit markets to fall. This same trust emptied
the brokerage accounts of believers twice in the past 13 years, but it goes on.
Zero Hedge recently reported the days on which the New York Fed has engaged in
POMOs (Permanent Open Market Operations) of $5 billion or greater, between
April 2009 and April 2013, the S&P 500 rose 540%. On days when POMOs were
less than $5 billion, the index rose 15%. On days without POMOs, returns were
-2%. (The New York Fed lists the daily schedules for POMOs with estimated sizes
several days in advance. The Fed wires the electronic, keyboard money to
primary dealers who relay electronically conjured money to recipients.)
Andy
Lees reports: "Asset prices have...continued to soar. Margin
debt is at record levels in absolute terms, and is towards record levels as a
percent of market cap. A week or two back I was told that hedge funds are
running a gross exposure of about 258%. If I remember correctly, derivatives
and financial sector lending is predominantly off balance sheet. What appears
to be happening therefore is that the loan growth is driving or supporting
asset prices, but it is being funded, at least in part, by taking liquidity out
of the real economy, similar to the late 1920's. Why would a bank lend to the
real economy where there is disinflation and the weakest nominal GDP growth
outside of recession, rather than to the financial economy where there is
massive asset price inflation and the banks can make returns very
quickly?"
Andy Lees described one path through which the world's
asset markets are inflated, by layers of leverage upon leverage upon leverage.
The central bankers remain completely unaware of this since their holy DSGE
model (dynamic stochastic general equilibrium model) does not acknowledge the
existence of financial markets.
Lees' comment, "liquidity out of the
real economy," is most apparent in falling household incomes. Falling
incomes partially answers the reason for record profits. A large part of the
increase in profit margins is due (as a percentage of revenues) to a reduction
of salaries, taxes, investment, and interest payments on debt. The last would
never happen except in a National Socialist economy, one that keeps setting New
World Records in corporate debt issuance with practically no carrying cost
(interest payments). When the Fed abandons its attempt to control the yield
curve (see comment about the 10-year direction, above), interest payments will
leave many a CFO admitting: "We have serious execution problems."
Companies also have serious liquidation
problems of their capital investment. The first run at the third quarter GDP
report pegged corporate investment at -0.1%. Record debt accumulation with
negative investment is truly New Era management, but, as in many New Eras past,
one that will vanish with a "poof." The main route for the debt is to
repurchase common shares. Fewer shares with record profits raises stock prices
and prods the cash-out rate of stock options by senior management: the 1%.
We may be heading into a melt up (the opinion of some long-time market
watchers), followed by a reckoning when it becomes apparent so many companies
have been hollowed out. To note the obvious, after the central bankers lose the
yield curve, their ability to support markets (first, the mortgage melt up,
then, 2008 and onward) will also go "poof."
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