The air underneath stock prices is indeed getting very thin at these altitudes.
According to none other than Goldman Sachs, median stock prices are positioned
at the 97th percentile of historic valuations. Other metrics such as Median
PE ratios, Market Price to Sales and Total Market Cap relative to GDP all validate
the extremely overvalued condition of U.S. stocks.
In order to justify these near-record valuations, analysts are once again
predicting a J-curve in earnings growth for next year. S&P 500 earnings
are projected to rebound from the trailing twelve months earnings per share
(EPS) of $111, to about $130 for the forward 12 months EPS.
The S&P 500 has produced five consecutive quarters of negative earnings
growth. According to FactSet, earnings growth for the index so far in the third
quarter of 2016 has a blended increase of just 1.6%. And even if earnings manage
to produce a small single digit rise in year-over-year earnings growth for
the first time in the past one and one half years, it would hardly support
near record market valuations.
Since 2010, economic growth in the United States has been slightly above 2%,
and for the first three quarters of this year GDP growth has averaged just
1.7%. Yet despite this anemic economic growth and shaky earnings backdrop,
perma-bulls are still betting on a huge earnings surge next year of 16% in
order to reach that illusory target of $130 EPS.
But the news coming out of multinational conglomerates so far this quarter
proves EPS won't even come close to that Wall Street earnings fantasy.
Right out of the earnings gate light weigh metals giant Alcoa blamed, "near-term
challenges in some markets" for missing its earnings estimate, as its revenue
declined 6% year-over-year.
General Electric lowered its revenue growth and narrowed its profit forecast
for the year. The multi-national industrial giant noted its revenue rose less
than expected, to just 1 percent in the quarter. The company also trimmed its
full-year revenue forecast, now expecting revenue to be flat to 2 percent growth.
Honeywell cut its full-year EPS guidance for 2016, noting that its core organic
sales are now expected to be down 1-2% for the year.
Manufacturer Dover (DOV) cut its full-year sales and profit forecasts, citing
a weak global economy. On their conference call they noted, "The primary factors
driving this revision are generally weaker capital spending across several
industrial end-markets..."
PPG Industries, who makes paints and coatings for the construction and other
markets, said it was, "disappointed with this quarter's EPS growth rate as
we continue to operate in a sluggish economic environment with no clear near-term
catalyst for improving global GDP growth."
Global construction and mining equipment maker Caterpillar reported an astounding
18% decline in its global retail sales for the three months ended Sep 2016.
The company cited listless demand for heavy machinery in its core markets due
to a slowdown in construction and mining activity. For the past few quarters
Caterpillar has suffered from a weak mining industry, low oil prices, stronger
U.S. dollar and China's economic woes. In addition to all this, its third-quarter
profit was cut in half due to the global economic slowdown that the company
expects to extend into next year.
3M sited challenges in its Electronics and Energy Sales Division for the reduction
in profits for 2016, which saw a decrease of $1.3 billion, or down 7.5 percent
in those key segments.
And finally, if you needed more proof, YRC Worldwide Inc., a leading provider
of transportation and global logistics services, saw its profit drop 9.5%
YOY, blaming a "soft industrial backdrop".
There are many more examples of earnings shortfalls, and to be sure, not all
companies reported bad numbers. Nevertheless, these earnings and revenue warnings
regarding current and future global economic weakness from multinational industrial
giants should not be ignored.
But it is not just multinational industrial conglomerates that point to a
lack of earnings growth. There are numerous examples of weakening revenue and
earnings--along with projections of further weakness—across various enterprise
sectors. For example; Fast Food chain Sonic dropped 17%, Home appliance maker
Whirlpool fell 11% and Sports Apparel provider Under Armour plunged 13%, all
on the same day they reported earnings.
It may have been acceptable for investors to maintain hope for a huge earnings
rebound as long as the epic bond bubble was still inflating (yields falling),
the dollar stopped rising, oil prices were well on their way back toward triple
digits and the Fed had your back. However, this is no longer the case.
Long-term interest rates have been rising sharply across the globe due to
the new central bank strategy of steepening their respective yield curves.
The Trade-weighted Dollar Index has jumped 4% since August of this year and
is up 20% since the summer of 2014 in anticipation of a resumption in the Fed's
tightening cycle. The price of WTI Crude Oil seems to be stuck below the $50
per barrel range, despite numerous attempts by OPEC to construct a deal to
freeze production at all-time highs. And, as mentioned, the weakening multinational
earnings picture has not yet dissuaded the Fed from recommencing its rate rising
campaign come December 14th. Indeed, the Fed's median dot plot projects short-term
borrowing costs will rise close to 1¼ percent by the end of 2017.
When near record-high market valuations slam into slowing global growth, rising
interest rates on both the long and short end of the yield curve and the epiphany
reached by investors that there will be no robust or sustainable earnings rebound,
it will lead to the end of this equity bubble. A prudent investor should listen
to the message of markets not the perpetually-inane optimism of Wall Street
analysts. Therefore, expect a 7-10% correction in the major averages between
now and the end of this year.
This selloff in stocks should continue until our inflation-loving central
bank returns to the printing press with the futile hope that a rising CPI will
bail out the economy. And even though stock prices may then catch a bid, expect
the chances of viable economic growth and a strengthening middle class to fall
further down the cesspool.
