Marcuard's Market update by GaveKal Dragonomics
With more than 450 of the S&P 500’s constituents having reported first quarter earnings, investors were sufficiently happy with the outcome of the results season to bid the index up to a new record close of 1,897 on Monday. In aggregate, the story told by first quarter earnings was more of the same—extraordinary margins, but lackluster growth. As a result, the pessimists expecting a collapse in growth or a mean reversion in margins have been doused with cold water. Equally, the optimists looking for break-out growth have seen their hopes quashed. Our main macro takeaway is that with demand growth still just muddling through, it is too early to bank on a significant rebound in capex growth.
First, the good news: margins remain near record highs, again averaging about 9.5% for the S&P 500 and again defying fears of a swift and painful reversion to their long term mean of around 6.2%. This is consistent with our view that the recent moves in long term yields do not present a risk to margins. In fact if the yield curve flattens it will be a net positive for most non-financial corporations. What could take margins down a notch would be a rebound in labour costs. We are monitoring this, but we don’t expect a swift or painful rise any time soon.
However, the bad news is that sales growth and profit growth continue to be weak. S&P 500 company releases give us a decent early indication of growth in domestic corporate activity. It is not a perfect measure. These days, a significant amount of S&P 500 sales and profits are earned outside of the US economy; so we will look to the national accounts profit data at the end of this month for confirmation. The two remain decently well correlated. It also shows that the trend in both is uninspiring.
Why are we looking at sales growth? Like many others, we are on the lookout for reasons to expect capex growth, which is currently stagnant, to stage a rebound. While we could look at business and consumer surveys, household balance sheets, capacity utilization, etc... the most reliable indicator we have found is corporate revenue growth. Our research shows that corporate sales growth tends to lead capex growth by two quarters—with a stronger correlation (0.73) and less noise than profit growth. This makes sense. Forget about record margins, company managers only tend to expand capacity after they get confirmation that demand for their products is on the rise.
Earlier hopes for a break out in demand growth this year have yet to materialize. To be fair to the optimists, first quarter activity was held back by lousy winter weather, and there are some indications (in PMIs, auto sales, etc.) that growth is now thawing out. Whether demand comes back stronger than it has been in recent years or simply returns to earlier lackluster growth rates remains an open question. Anatole is among those expecting growth to break-out. We tend to pitch our tents in the back-to-muddle-through camp. With a two quarter lead, we can afford to wait for an upturn in corporate sales growth before banking on a turnaround in capex growth. Unfortunately, the first quarter earnings season has delivered no such upturn. For now, we continue to expect lackluster capex growth.
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