Stocks have completely recovered from their flash bear market of late 2018.
But now they face a hard question: Can already record high prices continue to rise in the face of falling corporate profits?
Let’s start with the “falling corporate profits” part:
A business generates improving profits when the things it sells rise in price faster than the cost of production. So on the following chart you want labor costs to be flat or falling, and the other line – a measure of inflation – to be rising. But lately the opposite is true.
A big part of the past decade’s spike in corporate profits came at the expense of workers, who saw real wages stagnate while the cost of living rose. Now, with labor markets tightening and minimum wages rising, workers are getting a bigger slice of their employers’ revenues. That means shrinking corporate margins and, other things being equal, slower to negative earnings growth.
Now let’s look directly at corporate profit margins. Note that they stopped widening in 2015 as wage inflation began to bite. Then they spiked in 2018 when the Trump corporate tax cuts provided a one-time windfall. But that windfall is over and future comparisons will be with last year’s unbeatable earnings. As a result, public companies are going to report lower year-over-year profits going forward.
Why does that imply falling stock prices, especially when corporate profits stagnated between 2015 and 2018 while share prices kept rising? Because of what those rising share prices did to valuations. Stocks are now a lot more expensive both nominally and compared to earnings than they were in 2015, which means the air pockets under them are much bigger. They’re priced for perfection, and falling earnings per share is the definition of imperfect for the stock market.
Based on history, the next few years look brutal for the US stock market. Which raises yet another question: Is history still worth anything in a world of out-of-control central banks and hyper-profligate governments?
15 thoughts on "The End Of The Bull Market, In Three Charts"
Earnings are so 20th century. Endless credit and unlimited political power are the keys. There is only one fundamental, liquidity.
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The one thing left out here is share buybacks. The argument hinges on stocks being priced to perfection, which is measured as the P/E ratio. Corporations, however, still have all the power they need to manipulate the P/E ratio to remain exactly where it is via buybacks. They have scheduled as much in buybacks this year as they did last year. Since earnings are actually “earnings per share,” buybacks reduce the number of shares. Corporations have so much cash still stockpiled from foreign-profit repatriation or still have that repatriation to exercise that they will EASILY be able to manipulate their stock P/E ratio to remain exactly where they want it throughout 2019. Beyond that, I don’t know; but most have enough cash to do that until then.
I’ll go with the last line in this piece, which means ordinary logic and certainly history goes out the window when central banks and governments are involved in unprecedented activities.
Probably the main thing I failed to understand back in 2009 – when I was deciding whether or not to re-invest back into the stock market because of the Fed’s new QE program – was the power of “liquidity”, which basically means easy/cheap money. The newly created “money” by not only the Fed but all the other central banks of the world basically has to go somewhere, and its effect will be higher prices, and that is still going on primarily by the ECB (Europe), BOJ (Japan) and BOC (China).
I heard a similar sentiment from an interview of a former Dallas Fed advisor, and the founder and publisher of Quill Intelligence, Danielle DiMartino Booth. To quote her,
“I am guilty in my investing life of having fought the Fed, and what that means is that if you cannot appreciate the fact that liquidity is going to float financial markets then you are going to end up crying (in tears), and – again – that is something I learned the hard way, and that is you follow the liquidity and where it takes you, and you have to be agnostic about it even against the rational, logical methods that fundamentals are sending out about investments.”
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Besides the central bank float created by the ECB, China and Japan, there is a large cash hoard still piled up from foreign profits that were repatriated last year because many corporations did not spend anywhere near all that money, and then there are corporations that have not even exercised their one-time repatriation right yet. So, that means they still have tons of available cash to use to manipulate their own stock prices upward. To the extent that the principles use that money to buy their own shares out, they don’t have to worry about what comes after.
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How would you respond to the “milkshake” thesis that the dollar will strengthen dramatically (as will gold) and dollar inflows will propel the stock market to 40,000 on DOW and then the carnage will begin and gold end up the clear winner? (this is not Martin Armstrong’s theory)
http://financialsurvivalnetwork.com/2019/04/brent-johnson-the-milkshake-explains-it-all/
Well it is one senario, Anthony, and quite plausible. My feeling is that the market is behind the curve at present but the bond market knows more and is generally right in the end. Although the inversion is not complete,
My analysis indicates that the porrr corporate profit reports going forward will eventually impact the market. IMHO investors are relying on the Fed to come to the rescue once more – but I don’t think it’s going to work this time.
The main reason is to do with energy and EROEI. My book explains this and much more. For a free pdf of my manuscript email me at: peter@underco.co.uk
I also think it isn’t going to work because the economy is going to go into recession, regardless of what the stock market does. It’s certainly not unheard of to have a recession hit before a market crash (and the market really already crashed and got a huge hopium bailout from the central bank anyway. Once the economy goes into recession for a thousand reasons the Fed cannot control, then the stock market is bound to come down in response to the recession.
As you’ve followed with me Peter, you know my emphasis last year in my own articles was that a stock market crash was the big economic news for 2018. That is a fait accompli. It was bad enough to get the Fed to pull a face-losing hard stop on its long telegraphed plans. My emphasis this year is on a recession where whatever the market does is now secondary to that. The market is no longer the front-burner issue.
(None of this disagrees with your point but just adds another layer of support to your statement that the market is now behind the curve. It’s a following indicator now, rather than a driving force.) I don’t think we’ve ever seen an incomplete inversion like this one immediately preceding a recession, but that doesn’t mean an incomplete version is not sufficient. We just haven’t seen it happen at quite this high level of inversion to know. I think we are about to learn that this much inversion is both enough of a tell and enough of a driver to see recession follow even if the inversion never makes it to 2s over 10s.
Thanks Dave for your support and you are totally correct IMO. Recession is the name of the game and some say the USA is already in recession, if not, at the leading edge. So we are on the same page, which is comforting for me. Thanks again, I can sleep well in the knowledge that my investment strategy is correctly in place!
I would not be surprised at all to find out down the road that we got there ahead of my own summer prediction.
I too would not be surprised. Your forecasts are accurate because you look at the facts, unlike the Fed who are fooling themselves with their false models.