Profits of Doom

Ah, another day in Paradise. LIBOR spreads blow out again, mercantilist central banks ramp EUR/USD higher, and oil prints (yawn) another new all-time high. Pity the poor chaps at Deutsche Bank; these markets aren't getting any easier, and now they can't even treat their customers to an expensive lunch or a "show" after work.

At the risk of flogging a dead horse, Macro Man continues to be intrigued by the dichotomy of opinion on US corporate profits. Over the last week or so, he has received fairly bearish research from Goldman, Morgan Stanley, and JP Morgan. Yet other shops, such as UBS and Lehman, appear to be more sanguine about the outlook for US corporate profits. The low volumes that have accompanied the recent slew of earnings announcements suggest that the market has yet to see enough to make up its mind one way or the other.

Why is it important? The trajectory of corporate profits can help to determine or confirm the trend in a number of macroeconomic and market variables. In 2006-07, for example, Macro Man was fairly confident of a US "muddle through" scenario because of the strength of corporate profits, particularly when expressed as a percentage of GDP. However, recent data points suggest that we've finally reached the top of the cyclical, and perhaps secular profits cycle; a reversion to the mean (in terms of profits/GDP) would appear to suggest either a profitless recovery or declining profits in a recession.
One of the indicators that Macro Man likes to keep an eye on is a quick and dirty proxy for corporate margins, the annual change in producer prices less the change in consumer prices. To be sure, this is not a perfect proxy, as high energy input prices can actually represent quite a fillip for the profits of the energy sector, which has obviously been one of the leading lights of the mid-Noughties rally.

But still, the signs from the indicator are very ominous indeed; the prior three descents into "negative margins" all preceded/accompanied recessions; however, for most of the past several years, this indicator has been in record negative territory. Now some of the "profits anomaly" of consistent profitability (through the middle of last year) despite apparently negative margins may well be down to the energy effect, as XOM, et al rake it in. But can that explain all of the S&P's pre-3Q07 profitability? Perhaps not. Perhaps what we're really seeing here is the impact of "something-for-nothing" type structures like CPDOs, SIVs, et al, which have latterly proven themselves to be more expensive than advertised. Insofar as those avenues are likely to remain closed for the foreseeable future, perhaps profits will re-anchor with the apparently unfavourable margin environment.
And finally, to talk his own book, Macro Man presents once again the evidence that multinationals (typically large cap) are a preferable hold to smalls caps, which have a more domestic focus. Through Q4, the NIPA profits that were derived domestically unsurprisingly fell y/y, whereas foreign profits have been gangbusters. And what have we seen so far this earnings season? International earnings have been pretty darned strong from the likes of IBM, Google, Intel, and even GE.
Macro Man cannot help but think that the party's just getting started for the large cap/small cap thesis.
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Anonymous
admin
April 22, 2008 at 12:01 PM ×

well if agriculture prices indicate that more humans on this planet can afford to fill their belly, surely those same humans will be able afford buying things produced by companies as well?

a friend that has hitch-hiked most of this planet told me that even at the remotest place u go theres always someone selling coca cola.(even on CUBA!)

theres globalization for ya!

then tally man, u have to tell the bloomberg boyz that their columnist that believes theres a land shortage in argentina as the argies have planted soybeans, should have his employer pay his trip to argentina to have a look at the place. goddam such utter rubbish. hes spent all his life behind his desk both in school and at workplace peeking in nogood books? sheeesh...

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April 22, 2008 at 1:59 PM ×

MM, so you've underlined probably the most good indicator for EPS, probably naive but FUNDAMENTAL: CPI-PPI.
Firms are absorbing huge price hikes, burning their profit margin. And someone can keep higher their revenues due to GDP growth, but their earnings?? Just to remember, 50% of SPX earning are financial: does someone think that financial markets are in good shape??

To anon: do you think that a lot of cubans are spending 3 dollars for a bottle of coke when 50% of people in the world is living with 2 dollars for day??
I think that would be a fat western country man that needs a coca cola!!
I think that a lot of goods are repricing themselves to keep unchanged the access only to developed countries..

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Anonymous
admin
April 22, 2008 at 5:15 PM ×

Macro Man cannot help but think that the party's just getting started for the large cap/small cap thesis.

Why not the US is well on it's way to following the Japanese model of currency debasing it's way to prosperity.

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Anonymous
admin
April 22, 2008 at 6:25 PM ×

to: macro trading "no idea"

ever heard of "consumer price parity" ? or more popular "big mac index" ?

its right there in those nogood books of yours....sheesh...

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Macro Man
admin
April 23, 2008 at 10:59 AM ×

Anon, can we please keep it civil and leave the name-calling at the playground please?

And anon #1, I think what agriculature prices are telling you is that supply is not as price elastic as one might wish, because there are things like the weather that you can't control. Well, that and the fact that specs and ethanol have helped drive up the price, and rice exporters are hoarding product as well.

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Anonymous
admin
April 23, 2008 at 2:22 PM ×

not many men in this world know how to tally. all statistics and computing is based on this....

fewer still can reason...not always their own fault as they often have had disastrous teachers...

didnt know what to make of this blog that i was recommended.

now i know for sure...

thanks.

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Anonymous
admin
April 23, 2008 at 5:32 PM ×

The problem is the $500+trillion derivatives bubble that may pop at any time. This is all the fault of the Fed and other central banks and their policies of the last 20 years (at least). As the derivative bubble was inflated the central banks stood by, even encouraged it with glee. In fact in the US at least, it is the fault of congress who have the constitutional responsibility to administer and maintain a currency and system of credits. Therefor, we need to

www.TakBackTheFed.com

We need to do it NOW. Let's not sit around and wait fo the crash, open our wallets, and pay for it (not that what is in our wallets will necassarily be woth much). Let's take action now, and save our nation! Let's do so in consultation with other allied central banks.

Mark
www.siv0.com

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