Outside of the U.S., economic progress remains mixed. Activity in both Japan and the eurozone fell more than was generally expected, and China's economy is behaving marginally better than consensus expectations.
Today, despite analysts and strategists unrealistic optimism, participants' confidence in the markets is elevated as investors have cared little about slowing growth. I believe that reality will prevail, however, as ultimately corporate profits are the mother's milk of the markets.
Not only were fourth-quarter 2012 S&P profits and sales disappointing but forward guidance has been poor.
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.
At the start of the earnings season, the consensus forecast for fourth-quarter 2012
profits was about $25.50 a share -- now, with over 80% of the companies reporting, $23.50 a share looks more likely. (Missing fourth quarter 2012 by 8% is not a rounding error.)
A disappointing picture for S&P earnings lies at the core of my ursine market vision. In the fullness of time, an earnings cliff is not likely be ignored.
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 $103 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.
Markets discount the future, not the past, and stocks today are arguably as expensive as they were in 2007 based on:
- the loss of business sales momentum;
- the risk of mean reversion in profit margins;
- how far operating profit forecasts have fallen in the last few months; and
- that a projected hockey stick recovery in consensus profits is unlikely.
It is my expectation that projections for domestic economic growth will decline further in the months ahead, led by weakness in the consumer sector (previously discussed). This will further pressure corporate profits.
Already supportive of my slowdown thesis is the recent flattening of the yield curve, a lower absolute yield on the 10-year U.S. note (down by about 8 basis points in the last few weeks) and a recent rollover in several credit risk metrics (including deterioration in the high-yield debt markets).