Enzio's Clock

Background

1. Earnings and the Economic Time®

At its simplest, earnings rise when there is an excess demand of goods: that excess demand translates into higher revenues, so up go profits (assuming that costs stay low).

Not so this time around. This time, we have witnessed an excess supply of goods and rising profits.  How so?  As pointed out in the FT, and as we all know: costs fell faster than revenues, so up went profits.

This is, therefore, an atypical earnings cycle. As noted in said FT, "Over the past 15 years, S&P 500 companies have, on average, beaten quarterly estimates by 1.9 per cent. However, the 440 companies (i.e. 80% of all S&P 500 companies) that have reported third quarter earnings by the end  of last week    exceeded expectations on aggregate by 14.9 per cent - the highest level since the records began (in 1994)."

2. What happens when earnings exceed revenues

In order to maintain profits, either costs have to keep falling faster than revenues, or revenues have to rise faster than costs.

The excess supply of goods will remain for a long time - until around 2011 or 2012 (usually the Fed hikes rates about 2.5 years after the official end of the recession). Only at that point should the "jobless recovery" (like we had after the recessions of the early 1980s and early 1990s) morph into an excess demand for goods, as in: rising employment. 

So, n order for profits to keep rising during the current  excess supply of goods, costs have to keep falling  faster than revenues. This means even higher unemployment. My guess is that such cost-cutting will result in an unemployment rate of something hovering around 11 - 12%, an unprecedented rate since 1960.  

And if costs have to keep falling, then how on earth can revenues "all of a sudden" rise?

My view is that there is little room for extra cost cutting, implying that the stock market has over-reached itself on valuation.  In simple terms, people are paying a high price for non-earnings, or at least for a bleak earnings outlook courtesy of an excess supply of goods.

Now, with Central Banks starting to mutter something about exit strategies, we are facing the worst of all worlds: an excess supply of goods and an excess demand for money.  So there will be less and less liquidity around to go into (over-valued) stock markets whose profits outlook is bleak. 

It well could be the acceptance of this reality that has caused volatility - as measured by the VIX index - to rise precisely during the third quarter's reporting season...  As we will see in another note later this week, it is precisely this acceptance of a worsening Economic Time that will be a key trigger a sharp rebound in the dollar. Another point worth remembering from said FT article: "Despite the rush of pleasant surprises, the S&P500 has crept up barely more than 1 per cent since the start of the reporting season last month"...  Caveat emptor!

3. How to Make Money Off This Idea

1. Always consult your financial adviser first.
2. Short the U.S. market.  One ETF for this is SDS:US, which I own.