“What did you guys do? You drove these big death machines around?”
-Sam Hinkie
A pioneer on the statistics and data analytics front in the NBA with both the Houston Rockets and Philadelphia 76ers, Sam Hinkie recently became a professor of Negotiation at Stanford. As a former President of Basketball Operations and General Manager, he’s got some useful experience on that front.
In the quote above, Hinkie was providing some context on the power of long-term thinking by envisioning a future conversation with his grandchildren where he explains that in the old days humans used to drive cars around and run into each other.
In reality, there are probably many structural aspects of our daily lives that will be completely transformed in the next ten years. Those changes may come from technology much more unheeded than autonomous driving.
In any data series we come across on our team the first step is to hit “Max” on the Bloomberg chart page before doing more work on how the data fits in. Even so, we have to remind ourselves that most macro charts don’t go back all that far when we think about what’s in the realm of possibilities.
What may be a more subtle but underappreciated risk to the large amount of easily acquired data in modern finance is the anchoring & adjustment risk associated with trying to get an edge from historical data. More simply, this is the conservatism bias of placing too much weight on base rates or historical trends without a process to dynamically adjust for observable change (technological, environmental, structural).
Back to the Global Macro Grind…
“All-Time Highs”, “All-Time Lows”, or “Cycle-Highs” are easy and catchy call-outs and you need history before you have some good click-bait. Context, however, is key which you learn quickly.
As we show in today’s Chart of the Day the S&P 500 in aggregate is just barely off printing its all-time peak operating margin of 14% in Q2 & Q3 of 2017. Thirty years of operating margin history 1) is not a long time and 2) may not account for structural changes. Fine.
However, relatively easy compares, a QUAD1 margin story, anticipated tax changes, and the favorable currency translation effects for U.S. multinationals were a favorable bottom line cocktail that kept the earnings growth train going right through Q1 of 2018.
Even as compares became much tougher in some pockets of the market (this was something we outlined into Q1 as a potential second derivative growth headwind) the seventh consecutive quarter of YY earnings growth ended in peak second derivative fashion on both the top and bottom line.
Here are some notable earnings highlights as Q1 reporting season winds down:
- Broad-Based Strength: 480 / 500 S&P 500 companies have reported for Q1 and sales and earnings growth is +7.9% YY & +23.2% YY, respectively. For context on how growth rates held in, sales and earnings growth rates were tracking +9.4% & +25.1% YY at the halfway point. For the second consecutive quarter, every sector has reported growth on both the top & bottom line.
- Sales Growth: Sales growth for the S&P 500 index in aggregate is tracking at +7.9% YY with all but 4% of S&P 500 constituents having reported. If that growth rate holds, Q1 of 2018 will be the fastest pace of top-line growth since Q3 of 2011. Like earnings, this will mark the 7th consecutive quarter of sales growth and peak second derivative acceleration.
- Information Technology: The sector faced its first difficult comp this quarter. Going into reporting season, consensus Bloomberg estimates were for +20.6% YY earnings growth on top of 21.7% YY earnings growth in Q1 of 2017. Information Tech companies handily beat estimates. 62 of 68 companies have reported YY earnings growth of +28.7% in Q1 2018.
- Beat Rates: For more framing of what has been a very favorable backdrop, S&P constituents in aggregate have beaten earnings estimates by 7.0% this quarter. To put this in perspective, the 7.0% beat rate is the widest margin for a quarter since Q1 of 2011 which came on the back of Great Recession Era comps.
Steep growth rates from Q1 2018 have now been extrapolated into the future…. Seven quarters of earnings growth into peak acceleration will have that effect.
In aggregate for the S&P 500 Index, current YY bottom-line estimates for Q2 and Q3 of 2018 are running at +19.9% and +21.7%, respectively
Therefore, considering this base case earnings reality in its entirety, it is our view that a QUAD3 scenario is a real risk in coming quarters. Coupled with the late-cycle wage growth story, one of the signature slides in our macro themes deck the last few quarters shows the long-term, predictable relationship between corporate profits and wage growth (Slide 96 in the Appendix of the current deck). It’s just one of many we have shown on the timing of cyclical labor market realities. We have a well-rounded precedent that one is not good for the other.
Real-time market prices are already confirming this input price reality, which 1) further perpetuates QUAD3 tracking and 2) is a real risk to margins at the micro level. In some form or another, a majority of us have been taught that it’s easier to push price with demand growth. Sustaining the highest top-line growth rate since Q3 2011 (+7.9% YY in Q1) is an essential driver to stave off margin deterioration from the “All-Time Peak”.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.96-3.14% (bullish)
SPX 2 (neutral)
RUT 1 (bullish)
NASDAQ 7 (bullish)
Energy (XLE) 76.08-79.90 (bullish)
Industrials (XLI) 73.22-76.98 (bearish)
Nikkei 227 (bullish)
DAX 127 (bullish)
VIX 12.11-16.18 (bullish)
USD 92.20-94.30 (bullish)
Oil (WTI) 70.11-72.55 (bullish)
Nat Gas 2.76--2.99 (bullish)
Good Luck Out There Today,
Ben Ryan
Macro analyst
