Earnings are the lifeblood for long-term stock price appreciation. Over time, there is nearly 100% correlation with positive earnings growth and positive stock prices. If we look at earnings today versus where stock prices are today, it paints an interesting picture.
In the graph above, FactSet reports that so far for the upcoming Q2 corporate confessional (earnings season), that the number of S&P 500 companies pre-announcing negative EPS guidance is the second highest since 2006. For clients and regular readers of this blog, this should come as no surprise. Over the past several months I’ve been writing and speaking about how the economy, inflation, and corporate profits peaked in the 3rd Quarter of last year. I’ve also been writing specifically about a corporate profits recession for 2019.
Yet, the media is blaring its trumpets about all time highs in stock prices, so how do we reconcile? We reconcile this disconnect in several ways. One, from a calendar perspective (days, weeks, months, etc.) the “stock market” advance is quite long in the tooth. The probability of a meaningful advance from here is low. Two, from a cycle perspective, there is always some kind of lag between economic gravity and hope. It is clear that economic gravity is pulling most fundamental data lower, but the hope is that somehow the Fed or a trade deal will save the day. Spoiler alert: It won’t. Three, it is important that when we generalize the “stock market” that it is truly a “market of stocks” not a unified “stock market.” What I mean by this is that there are many sectors in the economy and not all of them preform in unison. Some sectors do great, while others do poorly. Like going to the supermarket, a spike in the price of meat doesn’t mean that price of doughnuts will also rise. Four, if all you are doing is looking at a single factor (price) as your basis for investing decisions, eventually you’ll inflict serious financial damage unto yourself.
If we believe there is a bull market somewhere, it is my job to find it. It is also as important to know what to avoid! So back to our trusty data crunchers over at FactSet, we see that they’ve broken down the S&P 500 companies that have have pre-announces negative EPS guidance by sector. FactSet has also included a 5-year comparison to help guide which sectors are better or worse.
For my playbook, given where we are in the economic cycle, inflation cycle, and profit cycle, it is important to stick with what has been working. Assets that tend to benefit from a declining yield environment should do well. You can think bonds, REITs, utilities, and gold. You’d want to avoid most anything technology, consumer discretionary, energy, and materials. The US dollar probably struggles going forward.
I’ll close out this post with a word of caution. If your playbook is to be long risk assets because of the hope of China trade deal or the Fed is going to lower rates in July or the chart looks good (sigh), I’d want to be on the opposite side of your positions. Meaning if you want to buy risk, I’d be happy to sell risk to you. Remember, to make money you need to first sell high and then buy low. It is true that after a Fed rate cut the short-term effect (a week or two) will be bullish for risk assets, but given were we are in the cycle, history will not be kind to your portfolio 3 to 6 months out. If you just take a step back and think about why the Fed feels the need to cut rates in the first place, your may come away with a different perspective on whether you’d be a buyer or a seller!
Hang on to your hats!
P. Franklin, Jr., CEO
All opinions and estimates included in this communication constitute the author’s judgment as of the date of this report and are subject to change without notice. This communication is for informational purposes only. It is not intended as an offer or solicitation with respect to the purchase or sale of any security. This information is subject to change at any time, based on market and other conditions. Any forward looking statements are just opinions – not a statement of fact.
Investing may involve risk including loss of principal. Investment returns, particularly over shorter time periods are highly dependent on trends in the various investment markets. Past performance does not guarantee future results.