Corporate scandals often seem to appear around market peaks. In this short blog, Jesse Felder shows how rising fraud shows up in corporate financial numbers and feeds through to stock prices and the broader economy. With several high-profile cases now unfolding, it’s a warning investors should heed.
Key Points:
- Earnings quality for the S&P 500 companies recently fell to the worst levels in 30+ years.
- Normally, cash flow should be greater than earnings because it adds back non-cash charges like depreciation.
- Low-quality earnings are those which exceed cash flow. It can mean companies are using accounting gimmicks to inflate their reported earnings.
- Another way to measure earnings quality is to compare “NIPA” profits from the GDP data with S&P 500 index earnings.
- When these diverge by 20% or more, as they are now, it is a sign reported profits may be artificially high.
In a truly booming economy, companies don’t need to exaggerate earnings. Hence, growth in such shenanigans is also a hint the economy is not a strong as it seems.
US Economy
- The January PCE inflation measure topped expectations…
- … particularly the core index. US inflation continues to run hot.
- The market expects at least three more 25 bps hikes.
- Treasury yields jumped, …
- The GDPNow estimate for the Q1 economic growth climbed in response to the consumer spending report, …
- The final U. Michigan sentiment index showed stronger consumer expectations.
- The headline durable goods orders index declined sharply in January,as Boeing’s orders decreased from a spike of 250 aircraft in December to 55 in January.
- But durable goods orders excluding transportation topped expectations. Capital goods orders, an indicator of business investment, were also robust.
- The ISM Manufacturing PMI orders index points to weakness ahead for durable goods orders.
- The Dallas Fed’s manufacturing index weakened this month as demand slumped.
- Factories reduced their workforce.
- More firms reported rising input costs.
- January new home sales topped expectations.
- But rising mortgage rates, and falling mortgage applications signal more pain ahead for new home sales.
- Inventories of new homes are elevated when measured in months of supply.
- The market is finally coming to terms with no Fed rate cuts in 2023. Here is market pricing for the fed funds rate change in the second half of this year.
- The Conference Board’s consumer confidence indicator surprised to the downside, as the expectations component slumped.
- The labor differential (“jobs plentiful” – “jobs hard to get”) once again points to a tight labor market.
- The spread between expectations and current conditions continues to signal a recession ahead.
- Regional indicators continue to signal weakness at the national level (ISM).
- Here is the aggregate manufacturing index from RSM.
- But China’s recovery could support US factory activity.
- According to the Conference Board, consumer inflation expectations continue to ease.
- However, the market is pricing higher inflation over the next couple of years.
- The slump in manufacturing production accelerated.
- Factories reduced their workforce.
- Input prices started rising again last month, which further spooked the bond markets.
- Separately, the ISM Milwaukee PMI is back in growth territory.
- Initial jobless claims continue to signal tightness in the labor market.
- Pantheon Macroeconomics expects jobless claims to rise in the coming months.
- The ISM Manufacturing PMI is pointing to slower hiring ahead.
- Credit card and subprime auto loan delinquencies have been rising.
Market Data
- For now, the S&P 500 is holding support at the 200-day moving average. We could see substantial selling if the index closes below support.
- The S&P 500 is entering a seasonally strong period. (2 charts)
Source: SentimenTrader
Source: @RyanDetrick
Quote of the Week
Life is hard, after all, it kills you.
– Kathrine Hepburn
Picture of the Week
Ukrainian territory held by Russia:
All content is the opinion of Brian J. Decker
