Economy Growing At Potential
The chart below is a unique perspective on the economy which isn’t discussed much. It shows the real GDP in relation to the potential GDP. It looks at productivity growth to give you an idea of where the economy is relative to where it can be. Even though GDP growth per capita is relatively low according to the past few decades of data, the economy is now growing at its potential. In the past 3 cycles, when economic growth reached its potential, it signaled the business cycle was close to ending. Before those 3 cycles, the economy grew much faster than its potential. You would think that growth higher than potential would lead to inflation. There certainly was higher inflation in the 1960s and 1970s than in the 2000s, so that’s a possibility. It’s possible that productivity growth can accelerate which would push up the potential. That would improve growth at the end of this business cycle. Ultimately, this chart is another example that the economy is in about the 7th inning of this expansion period (baseball has 9 innings).
The Trend Ends As Stocks Ramp On Beats From Wal-Mart & Cisco
The chart below shows the recent trend in the S&P 500. Stocks had been falling at the opening before rallying throughout the day. This prevented the correction from growing much larger than 1%. The selloffs would start overseas in Asia and Europe, pushing down S&P 500 futures before the open. Today ended that trend as the S&P 500 surged 0.82%. It was driven by an earnings beat by Wal-Mart. Wal-Mart destroyed its earnings expectations which is a great signal that the consumer is strong heading into the holiday season. This sent the stock up 10.90% to an all-time high. EPS was $1 which beat estimates for 97 cents. Revenue was $123.18 billion which beat estimates for $121 billion. Same store sales excluding gas sales were up 2.7% which was better that the expectations for 1.8% growth. Wal-Mart is a massive company, so these beats are large even though they would be normal for a small tech firm. Speaking of technology, online ecommerce sales were up 50% year over. This is the 1 year anniversary of the Jet.com acquisition.
The Nasdaq was up 1.30% as it was driven higher by Cisco’s earnings beat. As you can tell, even though only 17 S&P 500 firms are reporting earnings this week, earnings are still affecting the major indexes. Cisco stock was up 5.19% as its EPS was 61 cents which beat estimates by a penny. The interesting part is that revenue was $12.14 billion which is $260 million below last year, while the stock is up 19.40% in the past year. The earnings per share was the same because of buybacks. Investors are hoping the subscription model is able to help profits actually grow in the next 12 months. There’s also general market optimism which is helping the stock.
The chart on the left shows support for this argument that general optimism is helping Cisco. As you can see, stocks with good balance sheets are up about 20% in the past year while stocks with bad balance sheets have been stagnant. One of the reasons for this dynamic is because technology firms aren’t highly indebted. Cisco is one of those firms, but it’s obviously not one of the high growth FANGS. It wants to avoid being like IBM and instead have the performance of Microsoft.
The chart on the right aims to scare investors into thinking there’s a problem because interest coverage ratios are near the lows last seen at the depths of the recession in early 2009. However, the interest coverage ratios were lower in the late 1990s and early 2000s. Clearly if interest rates rise or if profitability declines, then weak firms will have a tough time meeting their obligations, but with record high profits and a corporate tax cut potentially coming down, there’s no reason to worry about corporate debt.
Speculation Isn’t High
One of the top arguments the bears make is that speculation is too high which means the bull market is near its peak. Stocks are expensive, but there needs to be a catalyst for them to fall. This speculation ending is a potential catalyst. The chart that the bears use to support their argument that speculation is excessive is the margin debt to GDP ratio. That’s a weird comparison because economic growth has little relationship to margin debt. That’s an apples and oranges comparison. A better comparison is shown below. It is the NYSE margin debt as a percentage of the Wilshire 5000 total market cap. As you can see, the margin debt spiked in late 2007 and 2000 which is around when the stock market topped. Now the margin debt ratio is very low, implying excessive borrowing to buy stocks like what happened in the late 1920s before the 1929 crash isn’t occurring.
The reason the margin debt to Wilshire 5000 ratio isn’t high like the margin debt to GDP ratio is because the stock market has increased faster than the economy. There’s nothing wrong with that because margins have increased and international sales have increased. If you want to make the case that stocks are in a massive bubble, you need to explain why software companies will see their margins decline and why international growth will slow. Stock valuations are certainly higher than average, but we aren’t at the brink of catastrophe like those committing chart crimes are saying.
Conclusion
Stocks broke out of their mini funk as earnings beats pushed the S&P 500 very close to its all-time high. The economic growth cycle is mature, but there isn’t excessive speculation as the margin debt to Wilshire 5000 ratio is near its normal percentage. With this week almost over, it’s safe to say the earnings season was a huge success. This should drive stocks higher in the next few weeks. I think a Santa Clause rally is in the works.
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