This commentary originally appeared at 9:20 a.m. EST on Feb. 11 on Real Money Pro -- for access to all of legendary hedge fund manager Doug Kass's strategies and commentaries, click here.
Similar to this past weekend's brutal blizzard, the interpretation of fourth-quarter 2012 U.S. corporate profits and the expectations for prosperity in 2013 is another big snow job. The current disconnect between stock prices and the slowing pace of earnings growth is reminiscent of the second half of 2007. The difference between then and now is 2007's emerging weakness was centered in the financial sector. By contrast, in late 2012 and expected in early 2013, the profit weakness is more broad-based.
Today, despite analysts and strategists unrealistic optimism, participants' confidence in the markets is elevated, as investors have cared little about slowing growth. Reality will prevail, however, as ultimately corporate profits are the mother's milk (hat tip to Sir Larry Kudlow) of the markets.
At the start of the earnings season, the consensus forecast for fourth-quarter 2012 S&P 500 profits was about $25.50 a share -- now, with over 80% of the companies reporting, $23.50 a share looks more likely. As Alhambra Partners opines, "missing fourth quarter 2012 by 20% is not a rounding error."
A disappointing picture for S&P earnings lies at the core of my ursine market views. In the fullness of time, it will not likely be ignored.
I continue to see an earnings cliff ahead.
Consensus, top-down and bottom-up 2013 forecasts for the S&P 500 are at $108 a share, $107 a share and $112 a share, respectively, up from about $102 a share expected in 2012.
My projection is for $100 a share or less for S&P profits -- well below 2013 consensus and under the anticipated actual 2012 earnings.
I was recently asked by Melissa Lee on "Fast Money," whether the S&P is cheaper today than it was when it made a high in 2007. In that appearance, I explained that markets discount the future, not the past -- and Zero Hedge illustrates my point that stocks today are more expensive today compared to 2007.
In this excellent post, Alhambra Partners demonstrates:
- the loss of corporate profit and sales momentum;
- how far operating profit forecasts have fallen in the last few months; and
- why an expected "hockey stick" recovery in earnings is unlikely.
It is my expectation that consensus projections for domestic economic growth will decline further in the months ahead, led by weakness in the consumer sector. This will further pressure corporate profits.
Already supportive of my thesis is the recent flattening of the yield curve, a lower absolute yield on the 10-year U.S. note (down by 12 basis points in last few weeks) and an apparent rollover in credit risk metrics.
It remains my view that the 2013 real GDP in the U.S. will be (at best) +1.5% -- the CBO has just issued a forecast of +1.4% -- and that there are accumulating downside risks to economic growth in the form of the fiscal drag of policy (given that the half-life of the previous über expansionary monetary policy of delivering zero interest rates is contracting).
With inflation running low, sales and profits will be challenged. Business pricing power is limited, but costs are likely to trend higher (raw materials, interest rates, etc.). Meanwhile, productivity is starting to decline -- it was down -2% in fourth quarter 2012 -- and unit labor costs are rising. This spells a threat to unprecedented and high profit margins, which are not likely to be as stable (as many prognosticators expect) but are more likely to mean revert (over the many years ahead).
Not only are fourth-quarter 2012 S&P profits disappointing but forward guidance is poor.
As I previously wrote, last month about 56 companies in the S&P 500 issued first-quarter 2013 earnings guidance: 45 were negative, and 11 were positive. That rate of negative guidance (80%) is the worst since FactSet started to keep these numbers (in 2006) and above the previous high established in last year's third quarter (74%).
Bottom line: Many market participants are inappropriately bullish on S&P profits and have ignored the recent downward profit revisions.