Economy
The end of earnings growth?

 If you look at the earnings growth, in 2010, the first year of the recovery, it had a sharp rise of above 100%. But since then it has been a downward trend. Corporate profits may soon be contracting

It’s earnings season. Like the calendar seasons there may be a change in the air. Since the middle of 2009, corporate earnings have consistently grown, but that might be about to stop. Before earnings are reported, it is traditional for companies to give gloomy forecasts to talk down the estimates, and then exceed them. This usually gives a pop to the stock when the company ‘beats’.

Not this time. With half the US S&P companies reporting, the percentage of companies reporting, EPS above estimates is in-line with recent historical averages, but the percentage of companies reporting revenues above estimates is below recent historical averages. The problem is that the ‘beats’ did not get the reaction that the companies would have wanted. The average stock has declined by 0.35% on the first day following the report of its earnings. It has been a particularly disastrous earning season for Tech stocks.

The average Tech stock has fallen by 1.6% on the day following its report. In the past year a ‘beat’ would usually mean a large rise in the stock on the following trading day. This season it results in a gain of 0.45%. While a beat does not lead to a celebration, a miss can be dire. If a Tech stock misses, its average decline is 6.71%. Twitter dropped 14%. Others have fallen 20% or more.

Are these numbers trying to tell us something? Perhaps. Certainly corporate profits have risen dramatically. If you look at a chart of earnings growth, in 2010, the first year of the recovery, it had a sharp rise of above 100%. But since then it has been a downward trend. Corporate profits may soon be contracting.

This should hardly be surprising. Corporate profits usually revert to mean. Presently they are close to an all time high as a proportion of gross domestic product (GDP). Exactly what the mean is, has been a matter of debate. The fact that they revert is not. The question between the bulls and the bears is, whether corporate profits are just a bit higher than historical averages and nothing to worry about or a bubble that is about to burst.

The bears will point out that the 2008 fall, followed by the recovery of 2010, was one of the largest spikes in history. The acceleration of profits has been much sharper compared to other business cycles. This appears to be surprising, given that economic growth has been tepid at best.

The explanation is not hard to find. Easy money policies provided by the US central bank have allowed companies to profit from extremely low borrowing. Low labor costs and a favorable tax codes have also helped grow profits even though demand has been weak.

For example Apple, the world’s most valuable private company, has boosted its earnings by buying back shares and keeping its profits off shore and away from American tax collectors. Although Apple has a huge $150 billion cash pile, $130 billion of that is outside of the US. To boost its shares and profits, Apple wants to buy back from $60 billion to $90 billion of its own shares. It doesn’t have the money in the US, so it has to borrow it. It has already floated a $17 billion bond 12 months ago and wants to do another $17 billion.

What is wrong with this scenario is that Apple is not using the money to invest in things that will actually make more money. It has simply utilised the conjunction of a generous tax policy and free money to engineer a rise in its stock which no doubt helps management. In the short run it has helped shareholders, but there may be problems down the line. Buying expensive stock with massive debt is not a lasting strategy for growth. Tax codes can change. Cheap money can disappear.

Like financial engineering, using cost cutting to boost corporate profits also has limits. Companies have tried to get as much out of their employees as possible without hiring additional workers. As a result, productivity has increased. Eventually, growth will demand more hiring as this week’s US job report may have indicated. But more workers will eat into corporate profits.

The result is that estimates for profit growth have been revised down substantially from the beginning of the year. Earnings estimates for the S&P 500 companies were revised down 4.4%. Of course this is quite common. In 20 of the past 25 years, analysts have revised down earnings growth by an average of 8% over the year.

It is not just the US market that is having second thoughts. European earnings estimates have also been wildly optimistic. Like the last three years, 2014 started out with 8% to 15% earnings growth forecast. In the past, these expectations have fallen over the year to -6% to 1% growth. Forecasts for European growth have moved from 13% at the start of the year to just 8% now and falling. Of the 374 Stoxx600 European companies that have reported their first quarter results so far this year, 101 have disappointed consensus earnings expectations.

Forecasts for global growth have also been cut. They started the year at 11%, but have since been cut to 2%. No doubt they will continue to fall as the year progresses.

The result of strong earning growths has been exceptionally strong stock markets that are trading at or near all time records in several countries. They grew by 13% in 2012 and managed a remarkable 24% last year. Market valuations always look to the future and over the past three years the future for corporate profits has seemed rather bright. With a change in expectations, no doubt there will also be a change in valuations. So corporate profits will not be the only thing to fall.

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and speaks four languages.)

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COMMENTS

SuchindranathAiyerS

3 years ago

Earnings cannot grow forever? Why? It certainly can't keep pace with spending. Consider "inflation":

Pune constable Jayashree Mane, an RTI user, slapped by her senior

Pune’s lady constable Jayashree Mane was slapped by her senior male colleague as he had to vacate his 'illegally occupied' official 'room'. Mane has filed over 200 RTI applications in a bid to cleanse the irregularities and corruption in the Pune police department. Will she get the justice?

Pune is one of the pioneers of implementation of the Right to Information (RTI) Act through the efforts and passion of citizens and activists. However, 34 year old woman constable, Jayashree Mane, who works at the Shivajinagar Police Headquarters in Pune, has shown unprecedented guts by using RTI to expose irregularities and corruption in the police department by filing more than 200 RTIs.

On Saturday, 3rd May, Ms Mane was on duty at gate no2 of Shivajinagar Police Headquarters, at around 9.30pm, when Police Sub-Inspector (PSI) Machhindra Shinde, senior to her and guarding gate no1, started walking towards her. His ire perhaps was hidden due to the fact that, he had to vacate his official `kholi’ (room), which he had been occupying illegally, after Ms Mane procured information to this effect, under RTI. Ms Mane, who was a few minutes earlier with her other women constable colleagues, was asked by PSI Shinde about their whereabouts. When she said that they have gone out for dinner, he seized the opportunity of her being alone, and slapped her hard across the face and ear. Ms Mane fell down and was writhing in pain. PSI Shinde ran away from the place.

Mane, approached her senior officer PN Suryawanshi to register a complaint, but she says, he wrote down in the station diary that she was not beaten up. Ms Mane then went to the Shivajinagar Police Station where the lady Police Inspector, Ms Mehendale wrote down a 'wrong' complaint to 'protect her seniors' says Ms Mane and compelled her to sign on it. She did not agree and insisted that PI Mehendale lodge a first information report (FIR). Finally, a non-congnisable offence was registered and so it is akin to a weak complaint.

Ms Mane has procured a medical report from the Sassoon Hospital and is in a perturbed state of mind. What is worrying is that, despite being a whistle-blower and exposing irregularities and corruption in the Police department, her seniors are allegedly trying to hush up the issue by denying her right to lodge a FIR.

RTI activists are very perturbed about the incident as it seems to be pro-accused than pro-victim. Hence, we are appealing to Pune Police Commissioner Satish Mathur with the following requests:

1. Ms Mane has played the role of a whistle-blower, by exposing wrong doings in the police department. We request you to give protection to Ms Mane by helping build up her confidence and assuring her that she will be given full justice. For this, we request you to ensure that the investigative officer hears her out fully and objectively, as she has allegedly been a victim of harassment at workplace and humiliation.

2. Ms Mane’s complaint to the Shivajinagar Police station has been treated casually. We appeal to you to register a strong FIR

3. The Central Information Commission (CIC) has directed that, in cases of assault or fatal attacks on RTI users/ activists, the RTI applications, the victims filed and the information provided to her/ him should be suo motu put up on the website. We request you to put up all the information that Ms Mane had sought including the documents relating to Mr Shinde’s allegedly illegal stay in an official 'room' immediately, within 24 hours. This will ensure that the accused is not shielded and that citizens know the kind of RTI applications filed by her.

4. We request you to look at the 'harassment in work place' angle as the physical assault on the night of 3rd May, seems like the last straw on the camel’s back

5. We also request you to act on this case quickly, seriously and in utmost fairness to bring it to a logical end. This will ensure that the faith of the people in the law enforcing system is not shaken.

 

I along with several RTI activists, including Akshay Dawadikar, met Mr Mathur and submitted our letter. After listening to our plea, the Pune Police Commissioner told us that the matter is being looked into.


(Vinita Deshmukh is consulting editor of Moneylife, an RTI activist and convener of the Pune Metro Jagruti Abhiyaan. She is the recipient of prestigious awards like the Statesman Award for Rural Reporting which she won twice in 1998 and 2005 and the Chameli Devi Jain award for outstanding media person for her investigation series on Dow Chemicals. She co-authored the book “To The Last Bullet - The Inspiring Story of A Braveheart - Ashok Kamte” with Vinita Kamte and is the author of “The Mighty Fall”.)

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Big banks, business and butter: Q&A on corporate impunity

Reporter Jesse Eisinger offers his thoughts on the lack of white-collar prosecutions, journalism and the Green Bay Packers

On the heels of ProPublica story last week with the New York Times Magazine on the rise of corporate impunity, reporter Jesse Eisinger took to Reddit to answer readers’ questions on regulatory challenges, changing the status quo and what it was like to star in “The Facebook movie.”

Below, a selection of the best. (We really recommend reading the whole thing.)

Q: What would it take to change the status quo? Frajer

A: A change in the culture of the Department of Justice (DoJ), where the leaders were more ambitious, were less afraid to fail and devoted more resources to the most complex cases. Also, the DoJ needs to start thinking about statutory fixes to address its loss of tools over the last decade.

Q: What one proposed law or legal change do you think would make the most significant difference?karmanaut

A: I don't think enough attention has been paid to the fact that the white collar laws are inadequate, so there haven't been many proposed remedies. One thing the DoJ should use is the "willful blindness" or "conscious disregard" charge. As Judge Jed Rakoff wrote recently in the New York Review of Books: Such a charge "is a well-established basis on which federal prosecutors have asked juries to infer intent, including in cases involving complexities, such as accounting rules, at least as esoteric as those involved in the events leading up to the financial crisis. And while some federal courts have occasionally expressed qualifications about the use of the willful blindness approach to prove intent, the Supreme Court has consistently approved it."

Q: Is part of the regulatory problem that technology (financial, corporate, communications etc) is evolving too fast for regulators to keep up?dvonya

A: Absolutely. They are outgunned technologically. The markets have become too complex for them. But that's not the only problem. A lot is will and leadership.

Q: Is a Pulitzer Prize a medal, a statue, or a certificate? Can you wear it around your neck?Ballacaust3000

A: It's a certificate but they make a statue of you out of butter and put it on the lawn in the middle of the Columbia campus.

Q: How much does wanting to get a job at these firms for big paydays affect the lack of prosecution of these executives? Should we restrict how easy is to go from the DoJ or the SEC to a financial firm?jerk40

A: This is a huge part of the problem. As a partner at a huge law firm, you can make ten times what you made as a prosecutor. If you are too aggressive or break the unwritten rules, that harms your future earnings. You go after easier cases to get wins and it helps if they are sexy cases (rather than boring, complex cases).

Q: Is the criminal behaviour limited to theft/ fraud, or are there specific types of financial transactions corporations engage in that are/should be outlawed?ningrim

A: Fraud writ large yes. There were many misrepresentations to the public that I think were worth deeper, more aggressive investigation. I write about the Lehman Brothers executives' representations of their liquidity in the weeks and months leading up to their collapse, which was clearly factually and materially inaccurate. Did they know it at the time? I don't believe the DoJ adequately investigated that question. And Lehman isn't alone.

Q: So in your opinion, what would it take to properly sanction big business? Also is it fair or right that a corporation is considered a person with rights equal to an individual?kevinb2k6

A: To properly sanction corporations, indictment has to be on the table. That includes seeking admissions of guilt and/ or being willing to take corporations to trial. However, I think prosecutors are justified in being concerned about an indictment leading to a corporate death penalty. But doing justice may require it. A dangerous, recidivist company might deserve to be put out of business.

Also, they must go after individuals as well. One way to do this should be to try to design fines that hit individual executives, not shareholders. Another is to charge individuals.

Corporations have rights as individuals and responsibilities. This is a long established precedent and won't be overturned anytime soon. I don't think the principle is a problem; corporations can make contracts, be sued, etc.

Q: What was the biggest threat you ever got from a major political/ business figure?bobthebobd

A: Well, financial reporters got it pretty good. The worst that happens to us most of the time is that high-priced PR people yell at us on the phone. Once, in the late 1990s, two detectives from the Manhattan DA's office were sicced on me by someone about a story I wrote on a Canadian billionaire pharmaceutical fraudster. I was so naive, I thought they were coming to feed me some information about their investigation of the guy. I didn't realize they were questioning ME until halfway through our meeting. Another time, my boss at the WSJ and current boss at ProPublica was summoned when he was on his honeymoon in Paris by Bernard Arnault, the French billionaire who owns LVMH, to complain about some of my columns. My columns stood up to the scrutiny and my boss backed me. I was deeply sorry my boss had to talk about accounting arcana on his honeymoon but very glad that I had pissed off Arnault that much.

Q: What would you consider the biggest mistake of your career? dvonya

A: I have made so many mistakes, I've given speeches about them. Fortunately, I've never made the kind of huge factual error that meant the story required retraction. Thank God.

One of my best stories was also one of my biggest mistakes. In October 2007, I wrote for Conde Nast Portfolio that the Wall Street investment banks were going to fail. I wrote that it would be Bear Stearns first, then Lehman Bros, and maybe even Merrill, Morgan Stanley and even Goldman. Pretty good, right? But I didn't follow up on it, probe deeper, write more. So I kind of blew the opportunity of a lifetime to really own the story of the biggest financial crisis since the Great Depression. Oh well.

Q: I have a list of questions:

As a journalism student in college, what should i be doing to get a job as a reporter when I graduate?

Did you naturally gravitate towards covering wall street or was it an assignment?
What's it like to win a Pulitzer?

Do you think the seahawks can repeat for the title? and if not who do you think will win?

Thanks for doing the AMA! – squirtgunheadphones

A: 1. Read as much journalism as you can, figure out what you like and who you like, cold call those reporters and try to meet and get a coffee. Study something that imparts real knowledge: science, statistics, economics, history etc. so you have some knowledge base and skill set. Look at all the start-ups: Vox, 538, Fusion, BuzzFeed (which is established, of course) and seek to get in on the groundfloor of those places.

2. I fell into it 20 odd years ago by luck. I honestly didn't know the difference between a stock and a bond. But I liked it, soon realizing that is where the power structure of society lay. So to understand how the country works, you need to understand finance.

3. It was great and I felt very lucky. But soon I started to worry that it would be my professional peak and that scared the shit out of me.

4. Obviously not and it will be apparent on week one, when the Packers crush them in Seattle.

Q: You were great in The Social Network and Zombieland. You're like Michael Cera except more awkward, its awesome black_caddy

A: I know it. I was robbed of the Oscar for both of those roles. Cera is a punk.

Courtesy: ProPublica.org

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