Wednesday, February 20, 2013

Despite Robust ‘13 Earnings, Indicators Suggest Potential Soft Patch Near Term

Executive Summary   

   The business or economic cycle has a considerable influence on the profitability of companies and, in aggregate, the overall profit cycle of industry sectors and equity markets.  In this commentary, we synthesize two approaches to measuring the economic cycle.  Based on that work, we ascertain how each asset class and equity economic sector perform in each stage/phase of the cycle.
Based on the performance of the three main asset classes (bonds, stocks, and commodities), a case can be made that the economic or profit cycle has moved from the early-cycle phase to the mid-cycle phase.  

Historically, in the mid-cycle phase, bonds begin to underperform, while equities and commodities generally continue to perform well.  

Likewise, historically, interest rate sensitive sectors such as Financials and Utilities underperform as more cyclical sectors such as Technology, Industrials, Energy, and Materials outperform the overall equity market.

While the strong performance over the past several months of a number of market-based indicators that suggest an acceleration of the profit cycle may continue in the long term, there are signs that economic and corporate profit growth may enter a soft patch in the near term. 

The profit cycle indicators we describe in this comment seem to agree with consensus estimates for corporate profits.  While both suggest strong earnings growth in 2013, the indicators and consensus foresee a soft match near term.  Given the market-based and “real-time” nature of the indicators, any change in the profit cycle outlook may become more obvious and timely.  

Link to Full Commentary