Ugly earnings by Monsanto today say sector selection will count during third quarter reporting season
The really ugly earnings report delivered today by Monsanto (MON) should go a long way toward clarifying the debate over calendar third quarter earnings. The company announced a loss of 19 cents a share for its fiscal fourth quarter that ended on August 31 and said that earnings would remain weak through 2016. Analysts had expected a loss of 3 cents a share. The company also reported that it cut 2,600 jobs or about 12% of its total workforce.
What’s that you say—you didn’t know there is a debate over earnings for the calendar third quarter? Earnings per share for the stocks in the Standard & Poor’s 500 are projected by Wall Street analysts to fall by 6.9% in the quarter.
End of debate, no?
Well, no. There’s a good possibility that the projected decline in S&P 500 earnings overstates the weakness in the quarter. The index, in comparison to the actual economy, over-weights the energy sector. Which raises the possibility that overall corporate profits—outside the energy sector–are better than projections for the S&P index indicate.
That side of the debate scores some points in the Federal Reserve’s report “Nonfinancial Corporate Business Profits.” In the calendar second quarter, corporate profits by the Fed’s measure climbed 11% year over year. That’s the most since the fourth quarter of 2012. In contrast the S&P 500 showed a decline in corporate profits of 2%, according to Bloomberg.
Goldman Sachs has an explanation for the disparity. The plunge in oil prices, revenue and earnings that is hammering energy company profits is one side of the positive effects of ultra low interest rates, low energy costs, and restrained wage growth has been good for company profits everywhere outside of the energy sector. Income in the third quarter is projected by S&P to grow by 10% or more in telecommunications, technology, consumer discretionary, and health care.
The big wild card for the overall earnings picture is the strong dollar. How will that affect profits for big U.S. exporters?
From the evidence in Monsanto’s report today, companies with big exposure to the negative effects of a strong dollar, with big exposure to commodities markets, and with big exposure to emerging economies are going to show disappointingly weak earnings. Monsanto took a hit as a strong dollar damped sales across Latin America and as the company continued to cut prices (although the worst of that seems to be over.) Monsanto continued to face pressure on its Roundup product from generic glyphosate with farmers looking to save money in the face of commodity price pressures. Brazil, where the economy is in recession, added to the decline in profits.
It would be a good strategy to focus on sectors experiencing solid profit growth and stay away from laggards—but if growth at the laggards is bad enough, it can, history says, take the entire market into a downturn.
Very careful and very selective buying would seem to be in order on dips in the stronger sectors of the market.
Well, I was sort of right in yesterday’s post when I said the reaction to today’s jobs report for September would tell us a lot about the worries and hopes of the financial markets.
Of course, what we got was one summary of worries in the morning and a totally different take on market fears in the afternoon.
And I was just a bit wrong about the numbers themselves. I thought that the numbers were likely to show a strengthening U.S. economy.
But… instead of the 200,000 net new jobs that economists surveyed by Bloomberg had projected, the U.S. economy added just 142,000 jobs in September. Revisions took a total of 59,000 jobs out of the figures for July and August. Average hourly wages, which were supposed to increase, instead fell by a penny from August. People left the workforce, again, with the labor participation rate falling to 62.4 from 62.6% in August. (Unemployment did stay at 5.1% thanks to the decline in labor participation.)
In the morning that news led U.S. stocks down with the Standard & Poor’s 500 falling 1.5%. Fear that the U.S. economy might be slowing and would therefore play into—rather than counter—a slowdown in the global economy drove the losses.
In the afternoon, however, stocks rebounded with the S&P 500 finishing up 1.43% on the day. In the afternoon session stocks, U.S. Treasuries, and commodities rallied as the U.S. dollar fell. The weak jobs numbers would postpone any Federal Reserve interest rate increase, investors and traders decided. The odds of a December increase fell to 34% from 46% before the data release, according to the Fed Funds futures market. Odds on a January increase fell below 50%.
With the likely first move on U.S. interest rates delayed later into 2016, the U.S. dollar fell. (A delay in raising U.S. interest rates removes part of the reason to buy dollar-denominated assets now.) A weaker dollar pushed up the prices of commodities denominated in dollars andalso led to yields on benchmark 10-year U.S. Treasuries falling below 2% for the first time since August.
So where does that leave us in terms of figuring out market sentiment?
Pretty much where we went in with financial markets suspended between fear of faltering global growth and hope for a delay in rates.
It’s interesting to me that the market did have a rationale for ignoring or at least downplaying the weakness in these numbers since the September and August jobs figures are notoriously subject to revision once government statisticians get a better handle on seasonal adjustments from the start of the school season.
But the market chose not to take that out. And instead took the drop in jobs at face value. To me that’s an indication that in the glass half full/half empty debate between growth and interest rates, the market is inclined to go with the half empty view that slowing growth is indeed the bigger worry. Earnings season could confirm that view if a large number of U.S. exporters complain about pressure on revenue and earnings from a slowdown in China and other parts of the global economy.
Last week’s (September 17) decision not to raise interest rates looks like it has come back to bite the Federal Reserve with a vengeance. By linking an initial increase in short-term interests from the current 0%-0.25% range to turmoil in China and other emerging markets the Fed has succeeded in throwing financial markets into confusion. In my comments on September 17 I said that a decision not to raise interest rates could increase volatility in emerging markets because it would leave traders and investors worried over when the Fed might move http://jubakpicks-1565237904.us-west-2.elb.amazonaws.com/2015/09/17/fed-does-nothing-today-but-speaks-clearly-comments-likely-to-put-more-pressure-on-emerging-markets/ . It now looks like I was too optimistic.
Exactly what is the Fed’s policy? Does the Fed need to see a lessening of volatility in emerging stock markets and developing nation currencies? How much of a lessening? Will a bit less volatility be enough? Does the Fed need complete stability in one market (China) or in all? Does the U.S. central bank need to be convinced that China isn’t about to devalue the yuan again before it moves? (Remember that China’s devaluation of the yuan by what is now 3% against the dollar threw global markets into confusion.)
The Fed had, up until last week, made sending clear signals of policy a priority. But it now looks like the central bank has squandered months of hard work.
And with no one sure what the Fed needs to see before it moves, traders and investors seem inclined to sell on bad news—or indeed on any news–just to be safe.
Almost all the world’s major stock markets are down today. The Dow Jones Industrial Average was down 0.48% at the close and the Standard & Poor’s 500 was down 0.34%%. In Tokyo the Nikkei 225 index was lower by 1.17% over night and in Europe the French CAC 40 fell 1.93% and the German DAX was down 1.92%.
The only exceptions came in China where the Shanghai Composite closed up 0.82% over night and the Shenzhen Composite moved ahead 1.21%. While that may seem counterintuitive—isn’t China the locus of fears about slowing economic growth?—the gains on the mainland Chinese exchanges are completely in line with the recent pattern of massive intervention organized by the Chinese government. That invention has followed a pattern of big purchases by these “friends” of the nation beginning in the afternoon and continuing to the close. And sure enough in today’s session buying began about 1 p.m. Shanghai time that lifted the index from 3124 to a close at 3134, a gain of 29 points from the low of the day and 27 points from the prior close. (Not a huge move, I’ll grant, but not bad under the circumstances.)
Commodity producers and industrial companies were hit on worries about global growth. Freeport McMoRan Copper and Gold (FCX), for example, was down 1.1% as of 1:30 New York time and closed down 0.1%. Caterpillar (CAT) tumbled 6.27% at the close after reducing its forecast for 2015 sales and announcing plans to cut as many as 5,000 jobs.
Federal Reserve chair Janet Yellen gave a speech on inflation tonight after the market close that stuck to the Fed’s assertion that an interest rate increase is still possible in 2015. Did she manage to explain Fed policy on the timing of an interest rate increase with enough clarity to calm traders and investors? I’d like to think so but any optimism is tempered by remembering that clarity isn’t the Fed’s strong suit.
The Federal Reserve did nothing today with its Open Market Committee voting, with only one dissent, to keep benchmark short-term rates at 0% to 0.25%.
But for once the Fed said something very clear—and very important—to traders and investors. Over and over again in the Fed’s statement it referred to the high level of global risk and volatility as the major reason for standing pat. For example, “The committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced but is monitoring developments abroad.” Or this “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.”
Why is this language important?
First, the Fed has pointed toward an indicator that isn’t likely to turn around very quickly. It’s unlikely, for instance that questions about falling growth rates in China will get resolved by the October or even the December Fed meetings. Volatility in the Shanghai market is likely to still be with us by then. And let’s not forget that commodity deflation, which is working to keep U.S. inflation way below the Fed’s target of 2%, shows no sign of ending quickly. By emphasizing global economic and market uncertainty, the Fed raised the odds against an interest rate increase in 2015 and raised them on a 2016 increase.
Second, by putting so much emphasis on global risk and global uncertainty, the Fed virtually guaranteed that traders and investors will pay even more attention to problems of global economic growth, emerging market currency weakness (and dollar strength), and the rising debt burdens of developing economy companies that used dollar-denominated debt for financing. Rather than ending the recent emerging market sell-off, I think that today’s statement may accelerate the downturn in the short term. (Frankly, I was hoping for a quarter-point interest rate increase today because I thought it would support sentiment on emerging markets.)
Tomorrow I’ll take a look at some research from investment bank Macquarie that argues that we’re looking at a long downturn in emerging markets.
In my post last night (http://jubakpicks-1565237904.us-west-2.elb.amazonaws.com/2015/09/16/are-financial-markets-losing-faith-in-central-bank-powers/ ) I flagged Japan as one of the countries where financial markets have growing doubts about the power of central banks to generate growth and higher inflation.
Standard & Poor’s has those same doubts, it appears. Today the credit rating company cut Japan’s long-term credit rating one level to A+ from AA-. S&P says it sees little chance that Abe-nomics will lead to stronger economic growth and higher inflation over the next two to three years. The downgrade comes just a day after the Bank of Japan decided NOT to increase its purchases of bonds. The bond-buying strategy is intended to keep interest rates low and weaken the yen in order to stimulate export-led growth.
Inflation in Japan has dropped back to near zero and the economy contracted in the second quarter. Public debt, the International Monetary Fund estimates, will rise to 247% of GDP next year. And with the country aging faster than any other developed economy the prospects of Japan growing out from under this mountain of debt are slim.
That debt load isn’t a terrible problem as long as yields on Japan’s debt remain low. (In fact, some cynics see the Bank of Japan’s policy of bond purchases as not so much a “growth” strategy as an attempt to monetize the country’s debt load by keeping government interest payments really, really low.) The yield on the government’s 10-year bond closed at 0.37% today after hitting a record low of 0.195% in January. (In comparison, the yield on a 10-year U.S. Treasury was 2.28% today.)
The downgrade is a direct result not only of the Bank of Japan’s decision to stand pat but also of an unconvincing fiscal reform plan released by the Abe government in June. As a plan for increasing growth by opening up closed segments of Japan’s economy, the effort wasn’t impressive or credible.
Today’s downgrade, which follows on a cut by Moody’s Investors Service back in December, isn’t good news for the future of the U.S. credit rating as the country goes into a bruising fight over a budget for fiscal 2016, another potential crisis over lifting the debt ceiling, and threats by conservative Republican to shut down the government again unless the new budget completely defunds all activities of Planned Parenthood. (By law no government money can go to fund abortion services, but that’s not enough, apparently, in this year’s battle.) The U.S. lost its AAA credit rating from S&P in 2011 after a fight over raising the debt ceiling and is now rated AA+ by S&P.
Just a word to the wise: The cut to Japan’s credit rating by both Moody’s and S&P indicates that the big credit rating companies haven’t decided to back away from potential downgrades of the world’s biggest developed economies.