From one of the biggest cheerleaders of the stock market, in recent months Jamie Dimon’s JPM has undergone a dramatic anti-Hugh Hendrian metamorphosis, turning increasingly more skeptical on further risk asset upside and as of one month ago, pulled the plug on its former cheerful nature when in early March it announced it had gone Underweight stocks “for the very first time this cycle.”
Today, JPM’s chief equity strategist, Misla Matejka is out with a new note, in which he tackles not the S&P500, where he has repeatedly said to take profits, but the weakest link of the economy, the one which Albert Edwards declared last week was “The “One Failsafe Indicator” Of An Inevitable Recession“, crashing profits. And not just profits of energy companies (which are expected to be down -104% in Q1), but in a total of 7 out of 10 S&P sectors (per Facset).
This is what Matejka has to say about the coming earnings season, and why he believes trouble is coming. First the good, if one may call them so, news:
Will upcoming Q1 results help market sentiment? It is the case that Q1 saw an inflection in some of the headwinds for US earnings – specifically, such as in dollar, oil, corporate pricing and a bounce in manufacturing activity.
Also, sharp downgrades to analysts’ estimates seen so far ytd have lowered the hurdle rate materially in the main regions. Consensus is forecasting S&P500 Q1 EPS to fall 6.9% y/y, the lowest run rate since the ’09 recession and down from +2.3% expectation at the start of the year. Seven of the ten US sectors are projected to deliver negative EPS growth. Expectations appear subdued for SX5E as well, at -4.7% ex-Energy, but are much higher for Topix, at +9.8%.
And now the not so good news.
This is where the good news ends. We worry that the top-line outlook, which is the key driver of operating leverage, remains subdued. Despite some improvement in US leading indicators due to temporary restocking, global activity was generally poor in Q1. The March PMIs failed to confirm the rebound in Eurozone and rolled over sharply in Japan, while consumer activity was especially sluggish.
USD weakening is a zero-sum game. It helps the US, but hurts Eurozone and Japanese earnings.
We reiterate our caution on Eurozone and Japanese equities, in part due to the increasing FX headwind. On the flipside, the rollover in USD, combined with improving activity momentum, should help EM, where earnings are still depressed in the historical context. Stay OW the space.
Overall, we believe that Q1 earnings will not provide much clarity, and we stick to our call from three weeks back that the Feb-March bounce in equities should be faded. Technicals are not supportive anymore and P/E multiples are at ytd highs.
Bond yields rolled over and the leadership of Defensives, which are beating Cyclicals by 100-150bp in the US and Europe ytd, and by considerably more since the ECB/Fed meetings, should continue. We note that MSCI Growth style is beating Value ytd in Europe by 210bp.
And then, JPM cuts right to the gist of its bearishness: profit margins.
Big picture, one of our key medium-term concerns for equities remains the outlook for US profit margins. We have argued since late ’14 that corporate profit margins appear to be peaking out for this cycle. The latest NIPA data are confirming the deceleration, with our model pointing to much more downside. Weakness is broad-based, with margin compression seen in all subcategories of profits: domestic, foreign, financial and non-financial.
We think this deceleration will continue as productivity remains depressed and the top line is unlikely to accelerate. Profit margins are a particularly useful indicator to assess the stage of the business cycle. In the past 60 years, there has never been a recession starting before the peak in profit margins. However, once margins have peaked, the likelihood of a downturn increases materially.
We believe that the rollover in profit margins will be a constraint for equities, as profits have tended to drive most economic variables, capex and employment in particular. It will also likely have negative implications for corporate activity, especially as M&A, buybacks and dividends are at cycle highs, and US financing conditions are deteriorating.
The conclusion:
We believe that the rollover in profit margins will be a constraint for equities, as profits have tended to drive most economic variables, capex and employment in particular. It will also likely have negative implications for corporate activity, especially as M&A, buybacks and dividends are at cycle highs, and US financing conditions are deteriorating.
Which means one can have rising wages or rising profits (and thus stocks), but one can’t have both. Unless, of course, multiples grow to even more ridiculous levels, and at last check the S&P’s GAAP PE is just shy of 24x.
Which also means the central banks’ mandate is clear: expand multiples to even bubblier levels.
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