Stocks Rising as Earnings Fall

Photo of hands holding pencil over documents while working with papers

Interesting news from the Age:

The chairman of failed Sydney stockbroking firm BBY took advice from a self-proclaimed psychic when preparing budget estimates and cashflow forecasts, the NSW Supreme Court has heard.

We don’t get it. Is there something wrong with that?

Excuse us for a moment while we hold an emergency meeting with our Financial Controller, ‘Mystic Sam’. Back in a moment…

Reasons to worry

For some time we’ve told you about our concerns with the market.

We’re worried that the market is only being held up by artificially low interest rates.

We’re worried that the US market is climbing higher, even though company earnings are falling.

We’re worried that companies are refinancing debt at low interest rates, with short maturities, in the belief that interest rates will stay low for the foreseeable future.

We’re worried about plenty of things. When it comes to the financial markets, we worry. But only because there are plenty of things to worry about.

As an aside, it’s one reason why we’re such a fan of gold. We view gold as an ‘insurance policy’ against the worry. Especially the worry caused by central bank and government meddling.

Now there’s another reason to worry. Not necessarily from a major crash perspective, but from a short term stocks-could-fall-up-to-20%-or-more-from-here perspective.

Here, we’ll show you. Check out this chart:

Source: Bloomberg
[Click to enlarge]

The upper half of the chart is the price performance of the S&P/ASX 300 index.

But it’s the lower part of the chart that I want you to focus on.

The orange bars indicate the percentage of stocks in the index trading at a 52-week high. The blue bars indicate the percentage of stocks in the index trading at a 52-week low.

You’ll notice an obvious point. When the index is rising, the number of stocks making a new high increases. When the market is falling, the number of stocks making a new high decreases.

We’ll concede this isn’t a breakthrough revelation. Rather, our point is that you’ll also notice that the percentage of stocks reaching a new high tends to occur just prior to a market downturn.

You can see this trend highlighted by the white trend lines we’ve added to the lower part of the chart. Looking at the cluster of highs following the recent rally, it wouldn’t be unreasonable to say that perhaps this forebodes a period of bearishness for the market.

Of course, this is backward looking. There is nothing to say that stocks won’t rally again from here (the Aussie market, at the time of writing is up more than 50 points).

Three weeks from now, we could be looking back at a new cluster of highs around this date. We tend not to think so. But then, we’ve admitted to being a worrier when it comes to this sort of thing.

You may agree (or not) that this chart gives us a justified reason for worrying.

So much for the savings

The budget savings for the government continue. As Bloomberg reports:

Australian parliament has this week passed almost A$11 billion worth of improvements to the budget over the forward estimates to 2019-20, Treasurer Scott Morrison says in e-mailed statement.

Good one. $11 billion eh? That’s $2.75 billion per year for four years. Excellent. Taxpayers will be happy.

Or they would be if it wasn’t for the fact that even after those [cough] ‘savings’, the Australian government will still be nearly $100 billion further in debt than it is today. That’s if the government’s own estimates on the budget deficit are true.

And we have no reason to believe they won’t be. In fact, we have good reason to believe the budget deficit will be even worse than forecast.

Why? Oh, we don’t know, maybe check out this report, also from Bloomberg:

The global iron ore surplus will take a step up next year and again in 2018, and that means prices are poised to take a step back, according to HSBC Holdings Plc. With supply topping demand through to at least 2019 on rising mine production in Australia, Brazil and India, prices are forecast to drop to $42 a metric ton next year and $41 in 2018, the bank said in a report. Ore with 62 percent content in Qingdao, China was last at $55.97 a dry ton after averaging about $54 so far this year, according to Metal Bulletin Ltd.

Iron ore was and remains one of Australia’s biggest exports. The iron ore price has already slumped from above US$140 a tonne a few years ago, to less than US$60 a tonne.

It has had a big impact on the profitability of the big Aussie miners. BHP Billiton Ltd [ASX:BHP] recently reported a US$6.4 billion loss.

Rio Tinto Ltd [ASX:RIO] recently reported a US$866 million loss.

As we recall to memory the venerable former prime minister, Kevin Rudd, there are clearly no ‘super profits’ there for the government to tax.

A continued surplus of iron ore in the world market would have an impact on royalty and tax revenue the government expects to reap.

The government says it can make $11 billion in savings. But that won’t count for much if tax revenue falls and therefore the requirement to borrow continues to rise.

Fun fact: Australian government debt now stands at $436.3 billion — not long until it hits half-a-trillion. How exciting.

Another reason to worry

We return to our worries…our worries about company earnings. From the Financial Times:

Oracle sliced its earnings forecast for the current quarter, as the combined effects of Brexit and a higher US tax rate hit its short-term profit prospects.

The earnings warning, along with weaker than expected profits and revenues for the three months to the end of August, wiped nearly 3 per cent off Oracle’s stock price in after-market trading.

These are exactly our fears. It’s why we continue to show you the chart showing the divergence between actual company earnings and Wall Street’s expectation of earnings.

As Oracle’s earnings illustrate, the market is excessively bullish about the prospects for US stocks.

We suggest that Oracle’s disappointing earnings won’t be the last disappointing earnings you’ll see from Wall Street in the months ahead.


Kris Sayce,
For The Daily Reckoning

Editor’s note: The above article is an edited extract from Port Phillip Insider.

Kris Sayce
Kris Sayce, dubbed the ‘Jeremy Clarkson of Australian finance’, began as a London finance broker specialising in small-cap stock analysis on London’s Alternative Investment Market (AIM). Kris then spent several years at one of Australia's leading wealth management firms. A fully accredited advisor in shares, options, warrants and foreign-exchange investments, Kris was instrumental in helping to establish the Australian version of the Daily Reckoning e-newsletter in 2005. He is currently the Publisher, Investment Director and Editor in Chief of Australia's most outspoken financial news service — Money Morning.

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