Don’t listen to the market cheerleaders: Today’s dour outlook is poised to get worse – The Globe and Mail

The global stock market, especially in the U.S., has spent much of this year correcting the deep oversold condition created in the December meltdown.

The S&P 500 just had “the worst December since 1931” followed by “the best January since 1987.” This is not the stuff that bull phases are built on. The volatility in both directions is very intense. It must be remembered that after a similar 20-per-cent market recovery in the opening months of 1932, the S&P 500 rolled over and ended up hitting fresh lows that spring. And as for 1987, we heard this last January, too – nobody seems to recall January of 1987 or 2018 as the most memorable in those years. Everyone only remembers October. Pack that in your back pocket. The key for successful investing is to stay ahead of the curve and not to live in the moment. And avoid the temptation of following the herd at all times.

The behaviour of the market has been fascinating and informative. While the earnings backdrop and outlook has been soggy to say the least, it is obvious that a ton of extremely bad news was priced in toward the end of last year. I say that because the research I have gleaned shows that companies that have beaten on both the bottom and top lines so far in this reporting season have outperformed the market by an average of 350 basis points when it comes to stock price performance (100 basis points equal one percentage point). This is nearly double the norm – average of the past three years – of 180 basis points. At the same time, even the companies that have missed on both profits and sales have only underperformed by 100 basis points and that compares to a typical lagging performance closer to 360 basis points.

That said, the average “beat” this quarter for earnings growth compared with analyst expectations has been 380 basis points – the bar was lowered last quarter – but this still is quite a bit below the three-year normal “beat” of 490 basis points. So beauty here is in the eye of the beholder.

And the guidance has been very poor as well. Halfway through the quarter, and we see four in five companies that have published guidance have done so negatively on profits; and nearly two in three have done likewise on the revenue outlook. I may have been too polite when I called the environment “spotty” before.

Let’s look at what is happening straight-up on the earnings front instead of “relative” to expectations. We have gone from plus 20 per cent year-over-year earnings per share growth from the first quarter to the third quarter of 2018 to plus 13 per cent for the fourth quarter; and the numbers I have seen suggest that net of the tax relief, that fourth-quarter performance is more like 6-per-cent growth. First-quarter EPS estimates haven’t just faced the barber’s razor but more like the butcher’s cleaver. The bottom-up crowd is now at minus 1.7 per cent year-over-year for first-quarter earnings – at the start of the year, the consensus was plus 3.3 per cent and back in October, the forecast was plus 6.6 per cent. And here you think the Federal Reserve did a mea culpa.

This is epic. On Dec. 31, the analyst community was calling for $40.21 EPS for the first quarter and now that is down to $37.95. A 5.6-per-cent downward revision in six-weeks time doesn’t happen every day, I assure you. The rose-coloured crowd says “oh, don’t worry – this is a repeat of 2016.” The “only” difference, which they don’t tell you, is that this is not just an energy story – six of the 11 S&P 500 sectors are in profit contraction, with tech leading the pack down at minus 10 per cent at the moment. This is a much broader story and a macro backdrop fraught with much more risk than was the case back then.

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Interestingly, second-quarter EPS growth estimates have also been shaved and we are just getting going here – now at plus 1.2 per cent year-over-year for the coming quarter. Looking at the guidance, one can reasonably assume that it won’t be long before this consensus forecast also swings negative, which will mark the first “earnings recession” since the first half of 2016. Again, the cheerleaders will try to convince you to take comfort in that – except that we endured a flat equity market for much of that year before the November, 2016, election unleashed a virtual wave of “animal spirit” investor emotion, with two 10-per-cent-plus corrections that same year to boot.

But last time, the jobless rate was a full point higher, the output gap still wasn’t closed, the yield curve was much steeper and the Fed had only raised rates once – not nine times along with the balance-sheet unwind. Totally different backdrop. And now the European Central Bank is done with its quantitative easing program whereas it stepped in to fill the Fed’s void three years back. Brexit has turned from a vote to a disruptive reality. Italy has replaced Greece as the EU’s fiscal basket case – it truly is too big to fail and too big to rescue. The tax-cut and deregulation wave is behind us. And even if we can avert a trade war with China, these complex battles among economic, cyber and technology lines are going to be with us for a very long time. China knows how to play the long game better than anybody else – the benefits of a central command political system.

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Be careful what you wish for.

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David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.


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