I just ran across the 1Q2023 “Guide to Markets” issued by J. P. Morgan Asset Management. This compendium of financial data is issued by a large team of their Global Market Insights Strategy Team. It consists of some seventy pages of data-packed charts, covering through December 2022. This information is selected to be of use to investors, both individual and institutional.
I was like a kid in a candy store, scrolling from one page of eye candy to the next. Without further ado, I will paste in some charts with minimal commentary.
One thing that caught my attention here was the persistence overestimation of earnings by Wall Street analysts. “Why do they keep doing that?” I wondered. A brief search led me to a 2017 article on Seeking Alpha by Lance Roberts titled “The Truth About Wall Street Analysis”.
Roberts notes that most Wall Street analysts work for investing firms. These firms want business from the companies that their analysts cover. Management of these companies makes it clear that they will punish any investment firm that gives negative coverage to their companies. So as a rule, the analysts tend to give rosy optimistic earnings estimates for intermediate (say one year) and longer terms, to make the companies look better. The other ploy analysts use is to progressively lower estimates as the actual earnings reporting time draws near. This gives the companies a better chance to “beat estimates” at the end of a quarter. Another tactic is to issue a neutral recommendation of “hold” when actually a harsh “sell” would be more appropriate. (See also Earnings Magic Exposed by Michael Lebowitz for more on this chicanery by Wall Street analysts.) Learning of this degree of bias of stock analysts was sobering, but it gives me a more realistic framework for relying on these estimates.
A couple observations from the charts above: First, the enormous rise in corporate profit margins. See here for explanations of this trend. The second chart seems a little ominous: companies are planning to raise prices, yet they expect lower sales. Stagflation, anyone?
Top chart above: The percent of unprofitable companies in the small-capitalization Russell 2000 index has grown from say 19% in 1998 to around 42% today. This contrasts with the raging high profits in larger companies, as noted above. Commentators have blamed the Fed’s suppression of interest rates post-2009 for allowing all these walking-dead “zombie” companies to stay alive, instead of going bust and releasing resources to more productive enterprises. If interest rates stay higher for longer, these zombies may finally perish. Bottom chart: Given the roughly 25% drop in stock prices in 2022, we will likely get a sweet rebound in 2023 (and in fact we were up about 7% already in January).
The federal budget, at a glance. Social Security, Medicare, and Medicaid account for nearly half of the spending; the direct taxation for these programs, “Social Insurance”on the right hand side, only covers 55% of the costs of these programs. Some 17% of the federal budget is from borrowing.
Ever wonder what’s under the hood of the Fed? Well, now you know. “MBS” is mortgage-backed securities – – banks and mortgage companies tend to not hold mortgages on their own books, but instead package them up into MBS’s, which they then sell into the investing marketplace. The Fed’s holdings rose after 2008, with round after round of “Quantitative Easing” (QE). Then, blam, in early 2020 the Fed suddenly bought an extra $3 trillion in various assets (mainly US. Treasury bonds, to fund the government COVID spending), and then kept it up until early 2022. Since then the Fed is reducing its holdings – as its T-bonds mature, the Fed does not replace them with new ones.
And finally, my personal favorite chart:
The blue line corresponds to the trillions of dollars in stimulus and other extra money that the government handed out in 2020-2021 due to COVID. The blue shaded area depicts the “Excess savings remaining” as we have merrily spent down that extra money, which seems to have driven much of our inflation (WAY more money chasing approximately same amount of goods and services). That extra consumer spending has also driven a lot of business activity, but this party looks on track to come to an end by late 2023. Hence, recession and hence rate cuts, is what most pundits seem to think will occur by year-end. The stock market is salivating at the thought of rate cuts – -bring on that easy money.
Re analyst expectations: sounds like there would be a market for unbiased analysis, or an aggregation of estimates from people who don’t have a stake in the firm they’re analyzing? Or “correct” individual analysts using their historic predictions, much like there are (R) pollsters, (D) pollsters, and independent ones with biases that can be calculated from historic data?
Re profit margins: The Barrons article explains high profit margins with profit-maximizing spin-offs and mergers. When you spin off your loss-making department, it moves from the S&P 500 to the Russel 2000. So, from the perspective of the overall economy, the large firm vs small firm profit difference seems to be just an accounting trick.
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Ha, good point: “When you spin off your loss-making department, it moves from the S&P 500 to the Russel 2000”
About unbiased analysis — I think most of the analyst recommendations that get publicized are from the so-called “sell side” – investment firms and the like. There are also “buy side” analysts who work for e.g. actively managed stock funds, who try to identify what to buy or not. These folks are incentivized to be correct – – too many wrong calls and they are out the door. But I think their research tends to stay in house, not get published.
See https://www.investopedia.com/ask/answers/difference-between-buy-side-analyst-and-sell-side-analyst/ for buy side vs sell side.