Dark Side of S & P 500 Underlying Earnings

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The brisk pace of Federal Reserve fueled U.S. corporate debt sales for the second quarter means that 2016 may come close to reaching last year’s record-breaking $1.3 trillion of deals.

Debt is a double edged sword, as net debt relative to the underlying earnings power of the S&P is at froth levels historically.

S&P 500

Net Debt to EBITDA*

2016: 1.5x

2015: 1.4x

2014: 1.25x

2013: 1.1x

2012: 0.83x

2011: 0.9x

2010: 1x

2009: 1.1x

2008: 1.15x


* x financials


Enterprise value (EV below in the chart) takes debt + equity market capitalization into consideration.  In the S&P 500, if you think of a pie with 12 pieces, five full of debt the other 5 equity,  it’s foolish to just focus on the stock portion of the market’s value, especially after eight year debt binge!

As the Fed has kept rates wrapped around zero going on 8 years, investor’s thirst for yield has companies reaching new dark heights in terms of their debt loads.  As the U.S. equity market has raged “risk on” since February, after the Fed agreed not to hike interest rates, stocks have become extremely expensive.  SELL Signal.

What keeps us up in the middle of the night is a surge in credit quality deterioration in the face of rising bond sales.  That’s NOT the way it’s supposed to work Janet Yellen!  S&P Global Ratings expects default rates among junk-rated U.S. cos. to jump from 3.9% in March 2016 to 5.4% in March 2017.

S&P 500 2006-2016

Investors are paying record prices for stocks when the debt portion of value is factored in relative to raw earnings power (EBITDA = earnings before, interest, taxes, depreciation and amortization).

The problem with most Wall St. strategists is they don’t get paid to get you off the dance floor, they want you in there swinging and playing.

The “Lower and Beat Game” is on Full Throttle

A look inside the S&P 500 shows, of the 460 companies that have reported, over 75% beat lowered consensus forecasts.

Keep in mind, if the bar is set so low, anyone can massage the numbers to exceed — and analysts had been aggressively cutting estimates for the quarter in the weeks before it ended.  Bottom line, Q2 will come in at -9% on the earnings front and -2.5% on the top line sales decline.

Buy Fear – Sell Complacency

We recommended subscribers buy fear in late January, there was value found in stock prices, today not so much.

“We’ve been putting cash to work as we believe a substantial relief rally is near and the Fed won’t be able to hike rates.  Great bull markets don’t end overnight. This bull withstood a violent blow in October 2014 with a 10% plunge and subsequent rally in stocks over 17 days. Last August / September, the bull took another sword, suffering nearly a 13% drop. We believe he has some fight left.. Buy the IWM Russell 2000 ETF.”

Bear Traps Report, January 20, 2016

A look at earnings year to date is not pretty.  We’ve crossed into our third of (year over year) declines, the S&P 500 is now trading at 19x earnings vs. 17x three months ago.

Over the last 40 years, 19x earnings multiples in the S&P 500 have been associated with 4-6% U.S. GDP growth, not 1.8% as we wear today.

S&P 500 PE


In early February the S&P 500 was trading at 17x earnings, today 19x

After the first two quarters, the S&P 500 is on track to make $107.70 this year vs expectations of $121.70.  We think the S&P will finish 2016 at $111.50 in earnings.

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How Rich?

S&P is at 2054

Earnings of $111.50 x 16 = 1784 S&P
Earnings of $111.50 x 17 = 1895 S&P


The data above is from Bloomberg and Reuters.






Retail Recession? 3 Things You Need to Know

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Street economists have blindly been focused on economic data in their effort to figure out what the Fed is going to do.  We’ve made the point, you’re far better off keeping a close eye on credit markets.

2s -10s

Over the last 70 years, the spread between the 2 year Treasury and the ten year has been a reliable economic forecaster.   If the economy is truly growing, creating sustainable wage pressure inflation, the spread between 2s – 10s will widen.  In other words, investors will demand a higher yield on long term bonds relative to what they’re receiving on short term paper.

The spread between 2-10s hit a fresh 8 year low last week (see below).

One of the Biggest Victims? 

Years ago, banks made upwards of 30% of their bottom line profits “playing the NIM.”  Net Interest Margins are vital to a banks long term sustainable profitability.   Simply put, banks borrow short and lend long term.  A flat yield curve is no friend of the banks, not to mention rising risks of recession.

Back in February, near the market lows on CNBC we recommended clients get long the banks to take advantage of fear and capitulation (the banks surged 21% from our buy call ).  Today we are sellers.

As you can see below, Mr. Market has been pricing in NIM pain in the US financials.

Last 52 Weeks

S&P 500: +0.30%

Financials XLF: -4.90%

2 10s

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A Warning from Retail

Retail stocks are now in a correction, off 11.7% from their April highs vs only -3.1% for the S&P 500.  The real warning sign is that in retail we’re seeing leadership in defensive names (recession proof stocks), while at the same time strong US Treasury demand.

Last year on CNBC, I was lectured by other guests that lower oil prices would be good for the U.S. consumer.  The problem, they ignored the multiplier effect of all those high paying jobs lost in the oil and mining space.  Association of American Railroads weekly rail traffic report for week ending May 7th: 492.9K carloads and intermodal units, -10.6% y/y.

How about that rock solid US consumer that was going to spend frivolously all these windfall dollars from lower gasoline prices.  At least they don’t spend it at Disney, Aropostale, Fossil or Macy’s and JC Penney.

Retail vs S&P
Divergence between the S&P 500 and the XRT Retail ETF

Wall St. and the U.S. 10 Year, Pure Comedy

Meanwhile, the gang that cant shoot straight has had another tough year trying to forecast the U.S. 10 year Treasury yield.  They’ve gone from 3.15% to 2.20%,.  The only problem is the ten year closed Friday at 1.70%.

We are sticking to our long held 1.40% target.

Median 10s 2