This morning’s release of the trade deficit numbers were less than impressive. Even more disturbing are the underlying trends. In December, the U.S. trade deficit worsened due to a jump in imports outpacing a rise in exports. That sounds good right? Not so fast. Remember, the month to month variations have little to do with discerning future outcomes. The trends of the data are far more important in this regard.
The trade gap expanded to $48.8 billion from $47.1 billion in November. While exports rebounded 0.7% remember that they declined a full 1.0% in November. Imports advanced 1.3% in December and were up 1.0% in November. However, the year over year trends are worsening showing potential weakness in the coming quarters ahead. The year over year decline in shipments points to weaker demand on both sides of the oceans. This is turn leads to weaker profit margins in the future which, when cost cutting is not available, erodes the bottom line. We can see that in the 4th quarter earnings announcements for the companies that make up the S&P 500.
The current increase in earnings in the 4th quarter, so far, is roughly 5.8% which is about half the growth rate in earnings from the first nine months of 2011 and much slower, about 1/5th the rate, at which they have grown since 2010. However, even that is a bit deceptive as Apple and AIG have made up a bulk of the growth in earnings in the recent quarter. According to FactSet: “Take away those two companies and profits for the remaining 498 are expected to grow a measly 1.1%”
Therefore, since companies have already cut costs to the bone over the last few years there is little wiggle room left when both the dollar value of trade declines as well as the prices of the products. The impact to profit margins becomes immediate. Of course, this also leads us back to the fact that despite recent improvements in the economic data, as of late, we are very likely to see weaker data in the coming months ahead (barring any further rounds of Q.E.).
The current detachment of GDP relative to the year-over trend of trade is a result of not only the warmest winter on record in the last 5 years but also the “pent up” demand and inventory restocking cycle from the Japanese earthquake shutdown last year. These two anomalies will have likely run their course soon, and when combined with weaker incomes and a rising “gasoline” tax as prices rise, will likely further sap consumer demand. We showed recently that consumers are already being forced to increase debt by almost $40 billion over the last two months of the year just to maintain their standard of living to wit: “That is why the recent increases in consumer debt are disturbing. The rise in NOT about increasing consumption by buying more “stuff” it is about just about being able to purchase the same amount of “stuff” to maintain the current standard of living.. This doesn’t bode well for corporate earnings or the economy.”
The darkening profit picture is obviously concerning considering the very high hopes of continued employment gains and further economic improvements by the mainstream media. However, for investors trying to chase the stock market NOW after 3 years of cyclical bull market, the very negative trend of net export prices has typically led not only recessions but also stock market declines.
The impact of negative pricing to corporate profits is evident in recent corporate reports. So far, with 2/3rds of companies having reported, many are making less profit from each sale. Companies are trying to raise prices but with personal savings rates low and the ability to access credit limited that may only be a short term fix. Of course, with a 20% of exports and profits coming from the Euro-zone the weakness generated from their recession is already evident as well as rising pressures from China.
Yes, companies are beating expectations currently, but only because the expectations have been lowered substantially from where they began last year. In the three months before companies began reporting profits last month, analysts cut estimates for profit growth by more than 50% and companies are still tripping over the lowered hurdles. If we go back to the original estimates we would see that the economy and corporate profitability are in reality deteriorating – not improving.
Lastly, let’s not forget that earnings are ultimately a reflection of the economy. They can detach from one another temporarily but ultimately they are tied to one another. Earnings have ran in front of the tepid recovery in the market from the recessionary lows. Like trees – earnings cannot, and never have, “grown to the sky”. Yet, somehow, it always catches the media, analysts and investors by surprise when earnings decline and the stock market along with them. The chart shows the long term swings above and below the growth trend of earnings. 4th quarter earnings are noted as well as the current level of estimates going forward.
The evidence is mounting that the current bull market cycle is long in the tooth. This doesn’t mean that it will all come crashing down tomorrow but it does mean that the bulk of the easy money has likely already been made. The current rally, which has been fueled by a lack of bad news and very low volume, is rentable but not ownable. Trade accordingly and watch the trends of the data – there is more to the story than meets the eye.