Macro Wrap – Earnings Still the Driver

by Enis May 20, 2013 7:56 am • Commentary

As U.S. stock market indices continue to make new highs, there are a number of explanations for this massive move in the past 4 years.  But what’s most telling is that global stock market performance has pretty much followed corporate earnings growth in that period.  U.S. corporate profits are at an all-time high, with the S&P 500 at an all-time high as well.  Other regions of the world have not been nearly as profitable, and stocks have under-performed.

John Authers of the FT presented the staggering differences in his article last night:

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Using Bloomberg data on 12-month trailing earnings per share, the divergence between corporate US and the rest of the developed world, particularly Europe, becomes clear. US earnings are rising, and at a record, 16 per cent above their pre-crisis peak from 2007. They are up 120 per cent from their pre-crisis low.

In emerging markets, earnings by this measure peaked in 2011 – above their peak from before the crisis – but are now on a descending trend, down 16.5 per cent from their post-crisis peak. And earnings for the MSCI “EAFE” index – covering the developed markets outside North America – look terrible, down 46 per cent from their pre-crisis peak, and falling steadily. A decade ago, the corporate world was growing more homogeneous, and geographic differences between stock markets were diminishing. No more.

Wherever the corporate US is generating its profits, it is not from revenues, which according to the scorecard kept by Thomson Reuters are exactly flat, up 0.0 per cent from the first quarter of last year.

This divergence has shown up in the charts for about 2 years now, as emerging market stocks led the bull market rally in 2009 and 2010, but have mostly declined since 2011.  The weakness in the commodity complex is one major reason.  European stocks have been especially weak since 2011 as well, when economic stagnation brutally hit profits, which have yet to recover.

Here is the 5 year weekly performance chart of the SPX (black) compared to 4 other major global equity indices (Euro Stoxx 50 in red, Nikkei in blue, Hang Seng in green, and the MSCI Emerging Market index in gold):

5 year weekly chart of global equity indices, Courtesy of Bloomberg
5 year weekly performance chart of global equity indices, Courtesy of Bloomberg

The U.S. is still the only major market that is trading higher than where it did 5 years ago, and it is also the only major region with profits higher than they were 5 years ago.  Corporate earnings still matter, and geographic variation is another illustration of that.

But earnings growth, or lack thereof, should also be the chief concern for the bulls.  S&P 500 earnings are only up 7% in the past 18 months, while the index is up almost 50% in that period.  The first part of the rally, from early 2009 to late 2011, was driven by rapidly improving corporate profits.  In contrast, the move higher since then has been driven by multiple expansion.

The U.S. is still the envy of corporations around the world, and for good reason given its enormous earnings advantage.  Yet, with flat revenue growth and only 4% earnings growth in the past year, U.S. corporations are likely getting a bit nervous themselves.