The market continues to behave like a roller-coaster.  But will this ride ever end?  In the past, the ups and downs of stock prices have always mirrored the ups and downs in earnings, but this relationship seems to have broken down – or has it? The below graph shows (up until December of 2019) how obvious the correlation is between the S&P 500 Index (blue line) and trailing earnings for the index (the orange line).  The initial selloff anticipated a drop in earnings for the 1st Quarter which was only partially impacted by the coronavirus lock-down.  The rock and roll pattern we’ve witnessed of late evidences the uncertainty of how the 2nd Quarter is going to pan out.

S&P500-earnings-history-2020-05-20-macrotrends

Most of the (upside) action in the stock market has been limited to the mega-caps (Microsoft, Apple, Amazon, Alphabet (Google) Facebook etc.) which now account for a substantial part of indices.  We’ve also enjoyed a significant rebound in the energy sector.   But the rest of the economy?

As reported in Institute for Supply Management®’s (ISM®) Spring 2020 Semiannual Economic Forecast, released Friday, they project the manufacturing and non-manufacturing sectors to contract this year, with manufacturing revenue forecast to decrease by 10.3 percent and services-sector revenue expected to drop by 10.4 percent. Capital expenditures also are projected to take a hit, and capacity utilization is expected to be down.

The great unknown isn’t really about the next quarter which will be awful, but what the rest of the year will look like in terms of earnings.  Are the mega-caps really immune or just laggards?  The ISM estimate of a decrease in revenues could underestimate what’s in store.  And because corporations are highly leveraged (years of borrowing to buy back their own shares) the decline in earnings will be a serious multiple of the fall in revenues.

Many pundits who expected a double-bottom have changed their tune and now believe we’ve seen the bottom.  It would be great if they are right, but if history is any guide the (revised) consensus, like every consensus should prove mistaken.   It’s sort of like the roller coaster, once you think the scary part of the ride is over, another one sneaks up to test your intestinal fortitude.




 

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About the Author

Malvin Spooner is a veteran money manager, former CEO of award-winning investment fund management boutique he founded. He authored A Maverick Investor's Guidebook which blends his experience touring across the heartland in the United States with valuable investing tips and stories. He has been quoted and published for many years in business journals, newspapers and has been featured on many television programs over his career. An avid motorcycle enthusiast, and known across Canada as a part-time musician performing rock ‘n’ roll for charity, Mal is known for his candour and non-traditional (‘maverick’) thinking when discussing financial markets. His previous book published by Insomniac Press — Resources Rock: How to Invest in the Next Global Boom in Natural Resources which he authored with Pamela Clark — predicted the resources boom back in early 2004.

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