Morning Comment: Earnings DO matter.

Weakening economy? Trump has nobody to blame but himself.

Needless to say, the focus today will be on Chairman Powell’s testimony in front of Congress…which begins at 10:00. Of course, President Trump is desperately trying to pressure the Fed to cut rates. This is no surprise…given that he front-end loaded all of his fiscal plans…and the effects of that fiscal stimulus are now beginning to wear off. Therefore, instead of having some nice economic improvement in the final two years of his administration (like other Presidents have tended to see…because they back-end loaded their programs), Mr. Trump has a weakening economy. In other words, the President has nobody to blame for the slowing of growth we’re now experiencing than himself, but that won’t keep him from trying to blame the Fed (and force them to boost the economy…and win re-election).

President Trump will have to agree to a trade deal this year

That’s not to say that President Trump doesn’t have another trick up his sleeve. When he eventually caves-in and seals a trade deal with China (whether it’s a good one or not), the markets and economy should get a boost. He will declare victory…no matter how much or how little he gets in return…but there’s no guarantee that any initial surge will last through the election if he gets an agreement too early. Therefore, he’s pushing the Fed hard now to buoy the markets/economy for a while longer…so that he has more leverage to play hard ball with China for several more months.

Fading fiscal stimulus = slowing economy....duh.

Anyway, with Mr. Powell’s testimony coming this morning, there is not a lot more we can add…as anything I say could become moot very quickly. With this in mind, I’d like to touch-on the issue of “earnings” one more time before the earnings announcement season begins next week. It’s funny, speaking of “fiscal stimulus”, we’re hearing some arguments that say we don’t have to worry about the slowing of earnings growth this year…because any weakening in this area should be expected after the big boost earnings received from the fiscal stimulus of the past few years.

Actually, I agree that it’s no surprise that earnings (and earnings estimates) are coming down after the effects of the fiscal stimulus are beginning to wear-off. In fact, this is something we predicted would happen on several occasions since the beginning of the year. However, I believe it’s ridiculous to think this is nothing to worry about when it comes to the stock market going forward.

It's rarely "different this time".

Basically, this argument says that earnings have risen so much…and have reached such a high level…that it doesn’t matter that their growth is beginning to slow. This is very reminiscent of what we heard a year ago…when a huge number of pundits said that the Fed’s tightening cycle would not hurt stocks…because interest rates were at such historically low levels. Of course, that didn’t work out well at all. (Yes, there was a lag between the beginning of the tightening cycle and the negative impact it had on the stock market, but I predicted that lag all along…due to the fact that there is almost always a lag between changes in interest rates and its impact on the stock market (in both directions). However, higher rates DID have a VERY negative impact on the stock market eventually.)

Earnings rose, but SO DID the stock market!

Again, I agree that the fiscal stimulus did help earnings grow the past two years…but that earnings growth also helped the stock market rally in a SIGNFICANT fashion!!! So the fact that earnings growth is slowing should create a headwind for further upside movement in the stock market!!!!! No, it does not mean the stock market is going to fall out of bed. Heck, even the “earnings recession” of 2015 did not create a bear market for stocks that year. However, it’s not a coincidence that 2015 was the worst year for the stock market since 2009 (until last year’s interest rate-induced decline)!!! 2105 was also a year that gave us a 12% correction in the middle of the year…AND ANOTHER 12% correction at the beginning of 2016. (BTW, those were the first corrections since 2011.) So although the earning’s recession of 2015 did not cause a bear market, it DID help create some volatility.

Okay, I readily admit that the two corrections of 2015 & 2016 had a lot more to do with the price of crude oil than on general earnings growth (although the crash in energy earnings certainly played a role)…but if you look at history, it actually tells earnings growth usually grows at a much stronger rate than the stock market rallies. In other words, a 25% boost in S&P earnings usually equates to a rally in the stock market that is much smaller on a percentage basis.

If you look at other times in the past when earnings bottomed and then moved higher…which induced a stock market rally…the rise in earnings is usually much stronger than the rally in stocks. From 2001 to 2006, earnings rose 209%...while the S&P 500 index rallied “only” 95%. (We measured that rise in the S&P all the way to the 2007 top.) Similarly, from the lows in 2008 until the 2014 highs, S&P earnings moved up about 500%...while the S&P 500 index rallied 215%.....Finally, if you look at this entire bull market from the 2009 lows until now…you see that the earning for the S&P have risen 630% while the S&P has rallied “only” 342%. (Needless to say interest rates fell during all of those time frames….thus they ALL benefited from “multiple expansion”.)

Stocks could actually be seen as being ahead of earnings today.

This is NOT what we have seen in the market place since the end of the last earnings recession. From the 2015 low in earnings until now, earnings estimates for the S&P 500 have grown 42%...and the stock market has rallied a similar 45%. So if anything, the stock market has rallied more than it should have vs. the growth in earnings we have experienced. The outlier is actually the one we’re seeing right now…as the stock market has rallied much more substantially than it usually does compared to is rise in earnings.

So what I'm saying is that since the stock market has rallied very strongly during this fiscally-induced rise in earnings, we should DEFINITELY worry that a weakening of the growth in earnings will have a negative effect on the stock market. In fact, if you look at the history of the level of impact earnings growth has on the stock market, one should be MORE worried about slower earnings growth, NOT less worried about it!......Of course, it could be “different this time”, but like I said above, that’s what they said about the rate hikes of last year.

Earnings are not everything, but they ARE important.

Don’t get me wrong, I am not saying that the only thing that drives the stock market is earnings. In fact, I have said repeatedly over the years, that the Fed’s QE programs have been a very important driver for this great bull market that has taken stocks higher by over 300% in the last decade (when earnings growth & economic growth has been anemic most of the time). However, I have ALSO said the fundamentals DO still matter. Therefore, if earnings growth for the full year looks like they’re going to move towards zero (or even negative), it’s not going to be bullish for the stock market. This will be especially true if we continue to see weakness in global growth…if a trade deal remains elusive…and if the Fed is going to be slow in implementing their rate cuts (and does not engage in QE…which has a much more direct & immediate impact on the markets).

Matthew J. Maley

Managing Director

Chief Market Strategist

Miller Tabak + Co., LLC


275 Grove St. Suite 2-400

Newton, MA 02466


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Posted to The Maley Report on Jul 10, 2019 — 8:07 AM
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