GLOBAL ECONOMICS AND POLITICS
Leo Haviland provides clients with original, provocative, cutting-edge fundamental supply/demand and technical research on major financial marketplaces and trends. He also offers independent consulting and risk management advice.
Haviland’s expertise is macro. He focuses on the intertwining of equity, debt, currency, and commodity arenas, including the political players, regulatory approaches, social factors, and rhetoric that affect them. In a changing and dynamic global economy, Haviland’s mission remains constant – to give timely, value-added marketplace insights and foresights.
Leo Haviland has three decades of experience in the Wall Street trading environment. He has worked for Goldman Sachs, Sempra Energy Trading, and other institutions. In his research and sales career in stock, interest rate, foreign exchange, and commodity battlefields, he has dealt with numerous and diverse financial institutions and individuals. Haviland is a graduate of the University of Chicago (Phi Beta Kappa) and the Cornell Law School.
Subscribe to Leo Haviland’s BLOG to receive updates and new marketplace essays.
In “Ticket to Ride”, The Beatles sing:
I don’t know why she’s riding so high
She ought to think twice
She ought to do right by me
Before she gets to saying goodbye”.
CONCLUSION AND OVERVIEW
In offering enthusiastic audiences explanations of past, current, and future United States stock marketplace levels and travels, diverse marketplace preachers tell competing tales. Their arguments and conclusions reflect their different marketplace perspectives and methods, including the particular variables they select and arrange. For a majority of devoted visionaries, American corporate profitability is a very important factor.
After-tax US corporate profits soared after reaching a trough in fourth quarter 2015, not long before the S+P 500’s major bottom in first quarter 2016. The noteworthy profit climb since 4Q15 surely encouraged the S+P 500 to jump from its 1Q16 trough.
Yet Trump’s remarkable triumph in November 2016’s Presidential election created (or at least magnified) faith that United States after-tax corporate profits would increase significantly in calendar 2017 and 2018. The S+P 500 galloped 15.2 percent higher from 11/4/16’s 2084 low to 3/1/17’s 2401 elevation. Thus hopes for greater profits probably greatly assisted the S+P 500’s sharp rally.
What is a key tenet (especially in the post-election period) in the gospel promoting a viewpoint of growing American corporate profitability and an entangled bull stock climb? Much centers on hopes that the Republican-controlled Congress will enact noteworthy corporate tax cuts. Related optimism for marketplace earnings (and stock) bulls includes possibilities for repatriation of corporate cash hoards, dramatic boosts in domestic infrastructure spending, and reduced regulatory burdens.
However, current sharp divides on the American political scene (including within the Republican congregation) and widespread lack of confidence in (and hostility toward) the President will make it very difficult for a notable change in the corporate (and individual) tax code to become law. Passage of legislation encouraging earnings repatriation is not assured. Moreover, neither is a monumental infrastructure spending scheme.
In addition, despite the fierce climbs in recent calendar quarters, profit highs for recent full calendar years do not manifest a clear trend toward moving to new heights. Full calendar year profits over the past few years have been about flat.
Disappointment relative to widely-forecast profitability gains may inspire S+P 500 price retreats. In any case, history reveals that several noteworthy bear moves in the S+P 500 have intertwined with noteworthy profitability slumps.
What is too high (too low), high (low), overvalued (undervalued), or reasonable/rational/average/normal (unreasonable, irrational, atypical/abnormal) for stock prices or other economic indicators is a matter of opinion. However, and even though stock valuations can appear very elevated relative for an extended period of time, some marketplace gurus nowadays proclaim that some measures show US stock valuations are on the lofty side.
Also, elevated share buyback levels also have helped to propel US equities higher. There are hints this pattern will not persist.
Current low US stock marketplace volatility, high American consumer confidence, and evidence that financial stress remains below average have reflected (and encouraged) the majestic bull climb in the S+P 500. Observers nevertheless should watch for changes in such measures.
A warning light for S+P 500 bulls is the failure the S+P 500 to motor much above the early March 2017 high. The subsequent record high is 5/16/17’s 2406. If the S+P 500 continues to find ventures much beyond that March 2017 elevation challenging, this arguably will signal that current optimism regarding future corporate profit gains may be ebbing, that the S+P 500 bull trend is tiring, or both.
So the failure of America to enact important corporate tax “reform” (tax cuts) or embark on a glorious infrastructure spending voyage may not greatly diminish future earnings expectations (or even actual levels) or significantly wound the S+P 500. But they might.
In addition, challenges to the bullish trend in US equities may come from the long run upward trend of US government interest rates (note the Fed’s tightening plan). Or, concern about US federal budget deficits (or debt problems elsewhere in the world) may march into view. Hopes for higher (or at least not falling) energy prices likely underpin hopes for higher corporate earnings (and profits) in that key financial sector. But commodities “in general” (and petroleum in particular) have fallen from their 1Q17 highs. Anticipated oil output levels from OPEC and its non-OPEC comrades probably will not significantly reduce still-high OECD industry inventories for at least the next several months. The broad real trade-weighted US dollar established highs in December 2016/January 2017, though it has slipped only modestly since then. Contrary to what many believe, increasing US dollar depreciation may help lead to or confirm weakness in the US stock marketplace.
FOLLOW THE LINK BELOW to download this article as a PDF file.
Ticket to Ride- US Corporate Profits and S+P 500 Trends (5-17-17)
“And I’ll be taking care of business, every day
Taking care of business, every way”. Taking Care of Business”, by Bachman-Turner Overdrive
CONCLUSION AND OVERVIEW
For a majority of earnest soothsayers, American corporate profitability is an important factor for US stock marketplace levels and travels. Use the S+P 500 as a benchmark for United States equities in general. In second quarter 2015, US after-tax corporate profits peaked (annualized basis). The S+P 500’s record pinnacle occurred alongside this, on 5/20/15 at 2135. It mournfully plummeted about 15.2 percent to its 1812 (1/20/16)/1810 (2/11/16) depth. Despite the S+P 500’s subsequent sharp rally, the current and near-term after-tax corporate profit trend likely will make it challenging for the S+P 500 to ascend much above (or even over) its May 2015 peak during the next several months. History reveals that several noteworthy bear moves in the S+P 500 have intertwined with noteworthy profitability slumps.
To explain past and current United States stock marketplace levels and trends, and in offering prophecies regarding future heights and patterns, diverse wizards tell competing tales. Their arguments and conclusions reflect their different marketplace perspectives and approaches, including the particular variables they select and arrange.
American and other corporations win or lose given amounts of money for all sorts of reasons. Factors influencing earnings and profitability change, as do the relative importance and interconnections of these variables. Long run inflation increases generally increase nominal values in general. Also, central bank policies, tax regimes, wage trends, and productivity (innovation; efficiency) developments influence sales and profits. The altitudes and paths of the US dollar, interest rate yields, and commodity prices also are relevant in various ways and degrees to particular corporations. Unemployment rates, fiscal situations (budget deficits), debt levels and trends (government, corporate, and consumer), regulatory structures, and population growth matter. America is not an island apart from the rest of the world; globalization has increased in recent decades.
Admittedly, the ongoing (extraordinary) very lax monetary policy of the Federal Reserve Board and other central bank guardians such as the European Central Bank, Bank of England, Bank of Japan, and China’s central bank helps underpin equity prices in America and elsewhere. Stock-owning audiences around the globe (particularly the praiseworthy investment community) as well as Wall Street institutions, public corporations, and the financial media friends generally adore massive money printing (quantitative easing) and sustained yield repression. Low interest rate yields for US Treasury securities (and negative yields for many government debt obligations elsewhere) encourage fervent scrambles for acceptable returns elsewhere. These often-alluring territories include stock realms (hunting for dividends and potential capital gain), corporate debt, and commodities. American inflation has been quite modest in recent years. Yet as nominal prices in general (all else equal) tend to rise alongside (or on a lagged basis) a climb in US nominal GDP, so will a nominally priced index such as the S+P 500.
The S+P 500’s retreat beginning in May 2015 interrelated with the preceding bear trends in emerging marketplace stocks and commodities (notably petroleum) and a further bull charge in the broad real trade-weighted dollar (“TWD”). Significantly, the S+P 500 (and stocks of other key advanced nations), emerging marketplace equities (“MXEF”, MSCI Emerging Stock Markets Index, from Morgan Stanley; 1/21/16 at 687), and commodities in general (broad GSCI at 268 on 1/20/16) all attained significant troughs around the same time in first quarter 2016. The US Treasury 10 year note yield low was 2/11/16 at 1.53 percent. The TWD established its recent high alongside these marketplaces in January 2016. This interconnection across assorted marketplaces assisted the rally in the S+P 500 from its January/February lows.
Thus to some extent, the recent weakness in the broad real trade-weighted dollar encouraged the ascent of the S+P 500. In any case, central banks did not want the TWD to ascend by much, if at all, over its January 2016 high. They likewise wanted to arrest stock marketplace declines.
However, suppose the TWD declines further from current levels, perhaps ten percent or more from its January 2016 elevation. Although the first stage of dollar decline has managed to spark and assist a S+P 500 rally, additional sustained depreciation eventually may undermine equity prices. Besides, even if the TWD fall from its January plateau does not reach ten percent, the S+P 500 nevertheless may slide lower. Marketplace history reveals that a weaker dollar does not inevitably (or necessarily) push US stocks upward. And also suppose US interest rates or inflation expectations sustain modest climbs. Rising US Treasury yields can help to lead S+P 500 prices lower. Assume commodities in general manage to hold onto much of their recent gains.
In this environment, further suppose US corporate profits (and those in related regions) continue to remain sluggish (or decline further). Then the S+P 500’s fall from its high probably will be significant, even though the Federal Reserve and its trusty allies will intervene with rhetoric and action to prevent dramatic stock marketplace drops (particularly watch the 20 percent bear market definition threshold).
FOLLOW THE LINK BELOW to download this article as a PDF file.
Looking Backward, Gazing Forward- US Corporate Profits and Financial Trends (5-3-16)
In recent decades, the overall United States debt outstanding relative to nominal GDP has substantially increased. America’s national willingness to accumulate debt (borrow and spend) generally has played an important role in the generation of its economic growth. It of course is not the sole factor. This national debt increase thereby has tended to boost (be a bullish factor for) equity prices, at least up to now. A significant cut in America’s debt burden (deleveraging) probably will promote a decline in the nominal after-tax profit to GDP ratio from current elevated levels. This reduction also may encourage a slowing of after-tax profit rises, or even encourage an actual decline in profitability levels. These processes in turn probably would be bearish for US equities. Debt levels and trends are not the only factor influencing US GDP, corporate profits, and stock levels and patterns. Will American corporate profits forever keep rising? History is not destiny, but they often have declined.
Besides, growing debt does not inevitably guarantee economic health, corporate profitability, or soaring stocks, whether in America or anywhere else. Sustained Federal Reserve monetary easing buys time and sells hope, but it does not solve the US national debt problem. History reveals that at some point more and more national debt can generate grave problems. America probably is at or very near the danger level from its current and near-term debt situation, not just over the so- called long run horizon.
Let’s place American after-tax profits in the context of economic output. The average United States yearly ATP level relative to nominal GDP from 1946 to 2011 is about 6.2 percent. However, during the marvelous Goldilocks economy, and even up to the present despite the ongoing worldwide economic crisis, this indicator has been remarkably strong. Recall lows of
3.1pc in 1986 and just under 5.0pc in 2001. Before the 2004 to the present period, the last high over eight percent was 1950’s 8.6pc. From 1951 through 2004, it exceeded seven pc only three times (1978, 1979 and 2004). Over 2004-2011’s span, the average jumped to 9.0 percent.
The ratio in 2004 was 7.8pc, rising to 9.7pc in 2005 and 10.1pc in 2006. Calendar 2006 thus established a new pinnacle (going all the way back to 1929 not just 1946). In the year the global financial crisis emerged, 2007, it remained high, at 9.2pc. Even in 2008’s savage US and worldwide downturn, accompanied by the plummeting S+P 500, ATP relative to GDP were almost 7.4pc. The S+P 500 reached a major low on 3/6/09 at 667. In 2009, that ATP/GDP relationship was 8.4pc. What about the fairly sunny recovery years thereafter? The ATP total for 2010 bordered ten pc of nominal GDP, with 2011 elevated at 9.8pc.
What was the ratio of ATP for first quarter 2012 relative to GDP? Nominal 1Q12 GDP was about $15.48 trillion (annualized). Corporate profits were about $1.67 trillion (annualized). This is about 10.8pc of 1Q12 nominal GDP, thus marching beyond 2006’s joyous Goldilocks Era height to establish a new record height for that measure.
Though 2Q12’s earning reporting season has not ended, news reports suggest the nominal ATP level is approximately in line with 1Q12’s, and maybe even a couple of percentage points higher. US 2Q12 nominal GDP inched up to about $15.60 trillion from 1Q12’s $15.48tr. Thus the nominal ATP/GDP ratio probably remains around record levels.
Alongside these lofty 2012 profit levels, the S+P 500 attained new highs relative to its 2009 abyss (4/2/12 at 1422, 5/1/12 at 1415). These spring 2012 levels neighbor the S+P 500’s final summit at 1440 on 5/19/08, though they remain quite a bit beneath the major high on 10/11/07 at 1576.
An army of intertwined variables interrelate to propel the S+P 500 up, down, or sideways. However, suppose ATP slide lower relative to first half 2012 heights and that the ATP to GDP relationship retreats to fairly near the long run 6.2 percent average. All else equal, this probably will be a bearish factor for the S+P 500.
FOLLOW THE LINK BELOW to download this market essay as a PDF file.
American Corporate Profits and the S+P 500 (8-1-12)
Recent historically high nominal United States corporate profit levels are a key factor inspiring many to buy and hold US stocks. Bullish forecasts regarding future net earnings, especially when such predictions extend out to misty medium term or murky long run time horizons, sustain and bolster this enthusiastic ownership. In turn, stock rallies sometimes boost optimism regarding potential corporate profitability and overall economic growth, for many have faith that equity marketplaces are forward-looking indicators for “The Economy”.
Has the US entered a blessed New Era of very high corporate profitability that will stretch happily out into the indefinite future? Probably not. Has America revived the wonderful time of the Goldilocks economy? Probably not. Higher nominal corporate profits and ascending nominal stock prices, when accompanied by rising nominal GDP, can assist national confidence and encourage spending in the short term. However, since the nominal levels are not the real (genuine) ones, they do not translate into an equivalent amount of real and permanent prosperity.
Yet even if very elevated corporate profitability does not continue, what may have caused a sustained notable upward shift relative to long run history in the ratio of nominal US corporate profits to nominal GDP? To some extent, it reflects corporate cost-cutting measures and other battles to improve efficiency. The easy money policies of the Federal Reserve Board (sustained low interest rates; money printing) and its allies and massive deficit spending (stimulus) perhaps play roles. But picture the context of sluggish to declining real US household income, still-damaged consumer balance sheets, high unemployment, weak housing prices, and very low consumer confidence. With that domestic (home) background, high US nominal corporate profits- and especially a more elevated nominal profit versus GDP ratio- also arguably reflects economic globalization trends and profits captured from overseas. If so, then relatively high American corporate profits do not entirely reflect (do not fully represent) actual overall US prosperity (“Our Economy”), merely that of many of its corporations.
FOLLOW THE LINK BELOW to download this market essay as a PDF file.
US Corporate Profits- Patterns and Perspectives (11-1-11)