Since we last looked at the S&P 500's expected trailing twelve-month earnings per share some three months ago, the future for the S&P 500's forecast earnings has grown dim.
We can see that's the case in comparing our previous 17 May 2013 snapshot of the S&P 500's expected trailing year earnings per share for the fourth quarter of 2013 (2013-Q4, ending 31 December 2013) with our new snapshot just taken on 15 August 2013. To put the situation bluntly, the spike in optimism that investors had for a significantly brighter future in 2013 just three months ago has collapsed almost back to where it was six months ago.
Here, we've been tracking the expectations for the fourth quarter of 2013. Looking at the trailing year earnings per share expected for 2013-Q4, we see that investors have decreased the level of earnings they expect to be reported for the S&P 500 in 2013 by $7.27 per share as compared to our previous snapshot that was taken just three months ago, with the new trailing twelve month figure now expected to be $100.91 per share.
This is close to the level that investors had first expected for 2013-Q4 back on 15 February 2013.
One observation we can take away from this edition of our earnings snapshot chart is that there was an earnings recession that ran approximately from the first quarter of 2012 through the first quarter of 2013, which we recognize in the revised earnings per share that have been reported by Standard & Poor for the S&P 500.
What's more remarkable however is that the earnings per share data that was originally reported during that period did not indicate that situation. Our trailing twelve month earnings per share snapshots for 15 January 2012, 20 May 2012, and 13 August 2012 all indicated that earnings were rising during the early portion of this period of recession for stock market earnings.
It's not until our snapshot taken on 8 November 2012 that we see that the earlier earnings data had been revised enough to indicate a slow-to-no growth condition in the U.S. economy. Since then, our snapshots taken on 15 February 2013, 17 May 2013 and the newest on 15 August 2013 all confirm that earnings in the private sector of the U.S. economy actually contracted during these quarters.
By contrast, the number of publicly-traded companies acting to cut their dividends per share each month provided a near real-time confirmation of those recessionary conditions being present in the U.S. economy. Our most recent reading of that data indicates that the private sector of the U.S. economy is still experiencing recessionary conditions, but is perhaps finally beginning to exit from them.
But then, as we keep pointing out, dividends provide the clearest signal of the state of the private sector of the U.S. economy. It's just a bonus that they are also the fundamental driver of stock prices.
In the latter part of 2012, the United States' economy was falling into recession.
We know this because we watched in real time as the forces of recession built up through much of the second half of 2012, as a surprising number of U.S. companies were acting to cut their dividends. That observation has since been confirmed by the S&P 500's earnings data, which reveals that much of the private sector of the U.S. economy was indeed experiencing at least an earnings recession in the last six months of 2012, as the level of earnings earned by U.S. businesses dropped below their previously recorded values.
Worse, following his re-election, the nation's President was also committed to doing the stupidest thing that a nation falling into recession can possibly do: hike the taxes of its most productive citizens.
That situation was like an oncoming train wreck that no serious observer could help but notice was about to happen. Even from the corner of 20th Street and Constitution Avenue in Washington D.C. - the headquarters of the U.S. Federal Reserve.
So, on 12 December 2012, the Federal Reserve did what it does best these days. They cranked up their quantitative easing policy machine to do whatever they could to compensate for the poorly-considered fiscal policy propagating from 1600 Pennsylvania Avenue in Washington D.C.
At that time, the Fed committed to boost its net purchases of U.S. Treasuries by $45 billion per month, on top of its monthly net purchases of $40 billion worth of Mortgage Backed Securities that had previously established on 13 September 2012 to fuel the growing fire within a U.S. housing sector that had recently gained traction.
So what happens to GDP when the Fed is adding a net $340 billion per quarter to the U.S. economy? At the same time the U.S. government reduces its spending by a small amount from inflated levels as it really cranking up its taxes?
The answer may be found through our tool below, where we've combined the indicated factors for the first quarter of 2013 along with the fiscal policy multipliers that have been determined for how each affects GDP in the U.S. to determine how each affected the nation's GDP in the first quarter of 2013. We'll have more discussion below the tool.
Update 30 June 2013: Here are the values you would need to enter into the tool below to coincide with the actual levels of government spending cuts, expected tax increases and the Fed's quantitative easing that took place in the first quarter of 2013, per the BEA's third estimate for GDP for the quarter and the change in the Fed's total asset holdings over the quarter (as estimated from the change from 26 December 2012 to 27 March 2013):
Government Spending Cuts (Federal, State, Local): -$24.2 billion
Expected Tax Collections from Tax Hikes: +$56.3 billion
Total Federal Reserve Quantitative Easing: +$295 billion
You shouldn't be surprised to find that we come very close to the BEA's third estimate for GDP in 2013-Q1 of $15,984.1 billion. If the amount of the Fed's quantitative easing in 2013-Q1 totaled up to $303 billion, our GDP multiplier of 1.0 for QE would be dead on target.
Through the U.S. Bureau of Economic Analysis' second estimate of GDP for the first quarter of 2013, the U.S.' nominal GDP is presently estimated to be $16,004.5 billion, just $15.1 billion, or 0.09%, off from what our fiscal multiplier analysis suggests it would be for the values we've entered in our tool above. Looking at the individual effects on GDP, we see that the tax increases were by far the biggest drag on economic growth in the quarter, with government spending cuts having a much less than a dollar-to-dollar impact.
But we find that the Fed's changes to its monetary policies would appear to have been more than sufficient to make up for the effects of these fiscal policies.
That difference is what appears to have given the U.S. such a different outcome that Spain experienced in 2012, where that nation saw no similar monetary policy that might have counteracted the negative effects of its destructive tax hikes upon its economy.
More About the Numbers in the Tool
GDP and Government Spending: The GDP ($15,864.1 billion) for the previous quarter (2012-Q4) was taken from the BEA's second estimate of GDP for 2013-Q1 ($16,004.5 billion), as was the number we entered for the change in government spending from the previous quarter (-$26.0 billion). We should note that $20.0 billion of this reduction in government spending occurred at the federal government level, with the balance being recorded for state and local governments.
2013's Tax Hikes
The total for the change in the amount of taxes in the U.S. is based on the fiscal cliff tax deal of 3 January 2013, which increased the Social Security payroll tax by 2%, as well as increased the tax rates paid by high income earners and also the tax rates for investments.
Social Security Payroll Tax Hike: Here, we estimated the additional amount that President Obama expects to collect through Social Security's combined employer-employee payroll tax of 12.4% in 2013 (as indicated by Table 2.4 of President Obama's FY2014 budget proposal) compared to what would have been collected under 2012's combined tax rate of 10.4%, arriving at a figure of $108.6 billion for the year, for which we assumed that one-fourth ($27.16 billion) would be collected in the first quarter of 2013.
Obamacare Taxes: We also took into account the tax increases that went into effect on investment income and upon high income earners as part of the Patient Protection and Affordable Care Act, which are expected to total $36 billion in 2013, one-fourth ($9 billion) of which we assumed was incurred in the first quarter.
Fiscal Cliff Income and Investment Tax Hikes: The remaining portion of tax increases taking effect were a direct outcome of the increases in the top income tax rates and upon investment income mandated as part of the fiscal cliff tax deal at the beginning of 2013, where a static analysis indicates that the $80.6 billion more in taxes will be collected in 2013, one-fourth ($20.15 billion) of which might be applied to the first quarter of the year.
Combined, these values total up to a tax bill for Americans that's $225.2 billion higher for Americans in 2013 than in 2012, which works out to be approximately $56.3 billion higher for just 2013-Q1.
About the Multipliers
We featured a discussion of the fiscal multipliers for government spending and tax policies in our previous discussion of Spain's disastrous economic choices of 2012. We're simply assuming that the fiscal multiplier for the Fed's quantitative easing programs is 1.0, however in playing with the tool above, we found that a multiplier of 0.955 would be sufficient to make the results match the currently known outcome for the United States' GDP in 2013-Q1.
That agrees with other evidence that indicates that the multiplier for the Fed's monetary policies has dropped below a value of 1.0 with the onset of its Zero Interest Rate Policy (ZIRP) during the previous recession. We should note that even with this lower multiplier value, it would appear that monetary policy can easily offset any negative effects from government spending cuts, because the GDP multiplier for government spending is considerably lower.
The same cannot be said to be true for tax hikes, where an outsized increase in the amount of the central bank's purchases of Treasuries and other bonds and assets would be needed to compensate for the destructive nature of tax increases on economic activity.
About Quantitative Easing
What is quantitative easing? Just watch the following video....
How has President Obama's view of the desirable level of federal government spending evolved since he came into office?
This is the flip side to our previous analysis of the government revenue forecasting ability of U.S. Presidents, in which we found that a President risks losing credibility for their economic initiatives when government revenues fail to match the forecasts they make in their annual budget proposals.
Fortunately for President Obama, his credibility isn't at risk of falling even lower with this aspect of the federal government budget. Instead, we will evaluate his judgment.
Unlike the situation with collecting revenue, where factors outside the U.S. government's control affect how much revenue it can actually collect, the federal government is fully capable of spending every single dollar it intends to spend. As a result, a President's budget proposal really represents their view of the appropriate level of spending needed to satisfy their political priorities.
Our chart below reveals how Presidential desires for federal spending have stacked up against reality for each the budget proposals made by both President Bush or President Obama for each of the U.S. government's fiscal year from 2004 through 2014 (FY2004 to FY2014).
Looking over President Bush's record, we find that the federal government's actual level of spending was often anywhere from $60 billion to $90 billion greater than the amount originally proposed by the President. This is largely the result of the U.S. Congress adding spending on top of the amounts proposed by the President. Generally speaking, this outcome suggests that President Bush's political priorities were largely agreed to by the U.S. Congress during his tenure in office.
By contrast, President Obama's spending proposals have always been considerably out of whack with respect to the general consensus within the United States for the appropriate level of federal government spending, which we can observe in the vertical separation between President Obama's desired level of spending and the actual amount of spending that has occurred during his time in office. Politically, we can observe just how out of whack President Obama's desires for spending have been in the near universal margins by which his budget proposals have been rejected in the U.S. Congress.
That however appears to have changed somewhat with his most recent budget proposal for Fiscal Year 2014, the first following his re-election, where President Obama would appear to have finally begun to rein in his ambition for higher spending to fund his political initiatives, as the amount of federal spending would appear to be anywhere from $100 to $200 billion more per year than what the U.S. government would have spent under an extended projection of President Bush's FY2007 budget proposal.
While the President's FY2014 budget proposal is anywhere from $100 billion to $300 billion less than what President Obama has previously proposed for the U.S. government to spend in any of his first-term budgets, it still runs a minimum of $475 billion above the President's historically non-credible forecasts for the federal government's revenue collections.
That's progress in evolving toward a more financially-sound budget, whose priorities are more in tune with those of the American people, but there is still a lot of room left for President Obama to continue his evolution in that direction.
How good is the President at predicting how much money the U.S. government will collect in revenue from year to year?
The answer to that question matters because when a U.S. President submits a budget proposal to the U.S. Congress, they are effectively putting the credibility of their economic programs on the line. If their revenue projections repeatedly fall short of what the government actually collects from year to year, it is an indication that either they are not in tune with the changing health of the U.S. economy or that their programs are not capable of promoting the kind of economic performance needed to generate the kind of revenue figures they anticipate. And quite possibly, both.
Let's take a closer look at the recent performance of U.S. Presidents. Our chart shows the amount of revenue forecast by President George W. Bush (dashed lines) and President Barack Obama (solid lines) for each of the U.S. government's fiscal years from 2004 through 2014 (FY2004 through FY2014).
In the chart above, the U.S. President's forecast for a given fiscal year is typically made in February of the previous year. For example, President Bush's budget proposal for FY2009 was released with its projection of the U.S. government's revenues through FY2013 in February 2008, nearly 8 months ahead of when the U.S. federal government's 2009 fiscal year began on 1 October 2008.
We note this particular revenue projection because it turned out to be considerably far off the target. Prior to 2008, President Bush's budget proposals had a high degree of credibility, as the federal government's revenues frequently came in at levels slightly higher than the President had forecast.
But in February 2008, President Bush's revenue projections for FY2009 and beyond failed to anticipate the financial system crisis that would take hold during the year, nor did it anticipate the record spike in oil prices that would subsequently lead to near collapse of the U.S. auto industry by the end of the year. Note the permanent fall in the number of Americans employed by the U.S. automotive industry in the following graph (shown in orange on the scale on the right hand side of the chart):
Consequently, in missing the deteriorating health of the U.S. economy during 2008, President Bush's economic agenda quickly lost its credibility during that year, even though it would have appeared to have been successful in the preceding years.
Meanwhile, President Obama's track record of revenue forecasts indicate that his administration has never had a good handle on accurately assessing the health of the U.S. economy, nor has his economic initiatives been successful in stimulating the kind of economic activity needed to meet his revenue projections.
We can see this outcome in our chart above by comparing President Obama's revenue forecasts with the heavy black line in our chart above indicating the U.S. government's actual revenue collections. Here, we find that President Obama's forecast revenues are almost always far more optimistic than the actual outcome. Much as President Obama's unemployment rate forecasts have been.
We can also see President Obama's forecast economic recovery following the 2008-2009 recession progressively get dragged out longer and longer with each year's forecast in our chart. Here, it appears that President Obama has taken a simple straight-line projection of President Bush's revenue projections from the FY2007 budget proposal as his idea of how much revenue the federal government would collect if the U.S. economy were to fully recover from the recession. This straight-line projection then sets the bar for determining how effective President Obama's economic growth programs have been by his own selected standard.
We should note that President Obama has set the bar at a very high level, as the revenue forecasts for President Bush's FY2007 budget proposal was issued in February 2006, just after the peak of the first U.S. housing bubble, in which government revenues were elevated over what they would be in more typical circumstances.
Still, it is clear that this is the standard that President Obama has selected to assess his own economic performance in office. With that being the case, it is also clear that President Obama's economic programs as presented in his annual budget proposals have repeatedly fallen far short of meeting their anticipated performance targets.
We therefore find that President Obama's economic agenda has never had much credibility, especially when measured against the President's chosen measure of success. Which is perhaps why each of his most recent budget proposals have been dead on arrival on Capitol Hill, as no U.S. Congress has acted to pass any of President Obama's proposed budget measures since 2009, whether the national legislature was fully controlled by the President's own political party, as in 2010, or not.
And that is perhaps the best indication that waiting for President Obama's economic recovery is a lot like waiting for a train that will never come.
The lyrics to the Matchbox 20 song by that name are here. They would seem to fit the political situation with President Obama's economic agenda fairly well.
Since we last looked at the S&P 500's expected trailing twelve-month earnings per share some three months ago, the future for the S&P 500's forecast earnings has become considerably brighter going forward. Which is good, because it also suggests that the U.S. economy went through a recessionary period in the second half of 2012, from which investors are now expecting a recovery.
We can see that's the case in comparing our 15 February 2013 snapshot of the S&P 500's expected trailing year dividends per share for the fourth quarter of 2013 (2013-Q4, ending 31 December 2013) with our new snapshot just taken on 17 May 2013:
Here, for 2013-Q4, we see that investors have increased the level of earnings they expect to be reported for the S&P 500 in 2013 by $7.47 per share from our previous snapshot taken just over three months ago, with the new trailing twelve month figure now expected to be $108.18 per share.
This is close to the level that investors had first expected for 2013-Q4 back on 17 January 2012. But then, back in those heady days, they also expected that the earnings for the S&P 500 in 2012 would be $12.80 per share better than the $86.51 per share that they actually turned out to be. (Note: Standard and Poor may continue to revise its earnings estimate for 2012 for some time still as more refined information becomes available and as companies might restate their previously reported earnings.)
Looking at the full range of values that investors have forecast for the S&P 500's trailing year earnings for 2012, we see that they have ranged from a high of $100.07 per share, which was recorded back on 20 May 2012, to a low of $86.51 per share, as currently estimated. The low value of $86.51 per share also would appear to mark the bottom of an earnings recession for the index.
So why didn't stock prices crash at the same time? Well, as we keep pointing out, earnings don't drive stock prices. Dividends do. And although this confuses many of the more dim-witted commenters at Seeking Alpha, the changes that have taken place in dividends since mid-November 2012 are almost entirely responsible for the rally in stock prices since that time. Or at least up to nearly the end of April 2013, after which the story changes.
But we don't expect that certain people will appreciate that we've already told that story, and don't feel compelled to dumb it down for their benefit....
Reference
Silverblatt, Howard. S&P Indices Market Attribute Series. S&P 500 Monthly Performance Data. S&P 500 Earnings and Estimate Report. [Excel Spreadsheet]. Last Updated 9 May 2013. Accessed 17 May 2013.
In playing our "what if" game with the S&P 500 last week, we announced that the chart we featured would be "the last updated version of this chart that we'll be featuring for some time".
But then, the S&P 500 set a new all-time high as measured by the value of the index' daily closing value, and what better way to mark the occasion than to feature a new version of that chart, which we will be featuring for some time!
Basically, we've retired the "zoomed-in" version of our chart tracking the change in the growth rates of trailing year dividends per share, which define the realistic future expectations for earnings, and the daily and 20-day moving average of S&P 500 stock prices and introduced the full "zoomed-out" version of the chart! Now, you can see everything that we currently see when we peer into our crystal ball! And, as an additional bonus, the expected future for the S&P 500's dividends per share in the first quarter of 2014 has stopped being an unknown wild card element and has crystallized into sharp relief.
Here's how to read the chart. First, we see that investors are still focused on 2013-Q2 in setting the pace by which stock prices are changing, which we observe in the continuing convergence between both the daily and 20-day moving average of the S&P 500's index value with the expected change in the growth rate for the index' dividends per share for this current quarter.
Since these values are both still below the level set by 2013-Q2's dividends per share, we can expect stock prices to continue rising in the near term. However that rally will tend toward stalling out as the gap between stock prices and expected future dividends closes up, as it is increasingly unlikely that S&P 500 companies will announce additional dividend increases that might have a noticeable effect upon dividend futures or stock prices before that quarter ends in June 2013.
In the absence of significant noise events in the market, that convergence will continue until investors shift their focus in setting stock prices toward a more distant point of time in the future.
There are three alternate and parallel futures from which investors might choose. In two of those three possible futures, represented by the dividend futures for 2013-Q3 and 2013-Q4, stock prices can be expected to fall rather dramatically, with a more severe correction in stock prices occurring should investors become focused upon the fourth quarter of 2013.
The third alternative future for stock prices would be the more positive future indicated by the available dividend futures for the first quarter of 2014 - if investors were to suddenly focus on 2014-Q1 today, stock prices would rise rapidly.
Unfortunately, it is unlikely that investors will suddenly focus on 2014-Q1 without having first focused upon either 2013-Q3 or 2013-Q4. Our comments in our chart above indicate the basic sequence that we expect the market will follow.
As for when the shift in focus might occur, 21 June 2013 would mark the very latest that we would expect investors to be able to sustain their forward-looking focus on 2013-Q2 in setting stock prices, as this is the date the futures contract covering the S&P 500's dividends for 2013-Q2 will expire. The likelihood of a shift in the forward-looking focus of investors is presently increasing with each passing day, and it is extremely likely that the shift will occur in the weeks before 21 June 2013.
As always, the potential for noise events to significantly affect stock prices without warning remains a factor, and a noise event of moderate impact could well trigger the shift in focus in how investors fundamentally set stock prices.
The Federal Reserve's quantitative easing programs remain a wild card element. Here, should the Fed act to dramatically change their rate of acquisition of U.S. government and government supported enterprise-issued securities, we would expect stock prices to react, with stock prices moving in the direction of the change. At present, the Fed's current QE program is having little to no impact on stock prices.
Aside from relatively minor noise in the market, the S&P 500 is continuing to behave as expected.
To underscore that point, let's revisit the "what if" game we started playing three weeks ago, following the Italian election fiasco noise event, when the S&P 500 had closed the previous Friday, 1 March 2013 with a value of 1518.20.
Playing "what if", we asked the question: "What if investors continue to focus on 2013-Q2 in setting today's stock prices and the change in the expected growth rate of dividends for that quarter stays constant with where it is today. How much would the value of the S&P 500 have to change on average per trading day to converge with that level by 21 March 2013 - the last day we have shown on our chart?"
We came up with an average increase of 2.75 points per trading day.
Spanning 14 trading days from 4 March 2013 through 21 March 2013, the S&P 500 would have to have risen to a level of 1556.70 before the end of that period for our "what if" game to hold true, a 38.5 point gain from the Friday, 1 March 2013 closing value of 1518.20 over those three weeks of calendar time.
The S&P 500 did just that on Wednesday, 20 March 2013, when the index closed at a value of 1558.71.
On Thursday, 21 March 2013, the market responded to a new noise event, with the S&P 500 pacing the reaction of global markets to uncertainty related to the EU's bailout of Cyprus' banks that day. But, that noise event was short-lived and the market recovered to close at 1556.89 on Friday, 22 March 2013.
So, aside from relatively minor noise in the market, the S&P 500 is continuing to behave as expected. Here is where the market stands at present:
This will be the last updated version of this chart that we'll be featuring for some time.
In the meantime though, here are three thoughts to consider for this week. First, not all noise events have a negative effect on stock prices. Second, following up a seemingly random comment of ours last week, you don't have to wait for a 150 point decline in the value of the S&P 500 for a clear sell signal. There are other, less clear ones that you might also consider!
And third, yes, what we've just demonstrated over the last three weeks is nearlyimpossible. We just have a knack for being able to execute that sort of thing.
We'll explain more of that second thought later this week....
Update 29 March 2013: Make that "sometime next week". We're going to take a day to savor the S&P 500's new all-time high and enjoy the holiday weekend!
Before we get to the end of this post, we're going to leave you in limbo. In more ways than one. Let's get to it, shall we?
The U.S. stock market, as represented by the S&P 500, is continuing to behave almost exactly as expected. Through last Friday, 15 March 2013, investors remained focused on the future as defined by the second quarter of 2013, and the rally in stock prices began to slow. Here's an excerpt of the story we foretold weeks ago, as just told by Reuters:
Stocks have soared in 2013, with the Dow .DJI climbing almost 11 percent to hit a series of new all-time highs while the S&P 500 .SPX has jumped 9.4 percent, falling just short of its all-time closing high after rising for 10 of the past 11 weeks. And yet, analysts for the most part see equities as fairly cheap.
The rally has slowed, however. In the last eight trading sessions, the S&P 500 has managed a daily gain of more than 0.5 percent just once.
Let's see how that played out on our chart showing the change in the growth rates of stock prices and the expected level of dividends in future quarters, which addresses some of the why's of what has happened in the U.S. stock market:
Right now however, the market is in a state of limbo. Not so much the boundary at the edge of hell, so much as we are now in a period where one future has ended, but a new one has not yet begun.
Specifically, we're referring to the conclusion of the dividend futures contract for the first quarter of 2013, for which the third Friday of March, 15 March 2013, marked the final date and the new dividend futures contract that will apply for the first quarter of 2014, which has not yet taken shape.
At present, we expect investors to remain focused where they are at present, on the future as defined by the dividend futures contract for the second quarter of 2013. At least, until they are compelled to look to a more distant future in setting their expectations while setting stock prices. When that happens, we expect many investors might wish for a return to the current state of limbo....
In the meantime, we thought it would be a good idea to update our detailed chart showing the current state of order in the stock market:
Going by this chart, a 150-point decline in the value of the S&P 500 would be a very clear sell signal - just in case anyone is considering setting up a pretty generous stop-loss order so they don't have to hover over their stock tickers. Please note that we're not saying that such a change is imminent and we note that there are some wild card factors at play in the market today that reduce the odds of such a thing happening to less than a 100% probability. Our policy however is to point things like this out when it matters most: when you still have time to figure out what actions you might need to take in response to such an event, just in case you might suddenly have such a need.
However, if you're the type of investor who believes in "reversions to the mean", we've just shown you enough to make you very nervous. We're afraid that you cannot be helped....
And because it will be extremely relevant to news that we are going to break on 19 March 2013, here is an updated version of our chart showing the various periods of order and chaos that have prevailed in the U.S. stock market since December 1991:
As for the news that we are going to break, it might very well affect your investment outlook, because it will represent a new wild card factor for you to consider. For what it's worth, that point at the very top of the dark red section of the chart above identified as "Chaos: 04-1997 to 06-2003 (Dot Com Bubble)" is the one that is especially relevant, but not because there is any sort of bubble at work in today's stock market (really - we don't believe there is much of any type of bubble at work in today's stock market at all.) We'll explain more later this week....
See? We weren't kidding. Welcome to limbo!
Update 8:50 AM EDT: Sharp-eyed readers will note that we didn't mention Cyprus in our commentary above. In our view, it's a noise event, but one that might appear to have an outsize impact considering where things stand in the markets today.
Did you know that we're in the final week of the first quarter of 2013?
It's true, at least where the dividend futures contract for 2013-Q1 is concerned. That contract is set to expire on 15 March 2013, which for us marks the day that a new dividend futures contract, for 2014-Q1 should come into existence shortly thereafter, which will allow us to see an extra three months further into the future!
And here you thought the first quarter of 2013 would really end on 31 March 2013! (For reference, futures contracts typically expire on the third Friday of the month ending the quarter in question, which just happens to be super early this quarter considering how the days fell this month.)
Until then, not much in our outlook has changed, as the market is continuing to behave pretty much as we've expected:
As you can see in our chart, the expiration of the futures contract for 2012-Q4 on 20 December 2012 marked the timing of the most recent shift in investor focus. In that case, investors shifted their focus to the more distant future quarter of 2013-Q2, when they had been much more atypically and nearsightedly focused on the then current fourth quarter of 2012.
It will be interesting to see which alternate future path stock prices might take. If they stick with 2013-Q2, the current rally will start to stall out. If they focus on 2013-Q3, stock prices will fall around 20% on average from their present level. If they focus on 2013-Q4, then the dive will be deeper, with stock prices plunging around 50% on average from their current level.
The new wild card is the expected future for 2014-Q1, which we won't see until next week at the earliest.
As for the old wild card, we had an interesting thought - what if investors are really focused on 2013-Q3 right now and the only reason stock prices are this elevated is because of the Fed's latest quantitative easing program?
In that case, we would expect to see a lot more volatility in stock prices given the artificial nature of that kind of support. And while we've seen some volatility in very recent weeks, until the Italian election fiasco, the market was mostly characterized by a lack of it.
Instead, what we've seen is more consistent with investors focusing on the expected dividends to be paid out in 2013-Q2 in setting stock prices, with the kind of volatility that we associate with the market's typical level of noise. In fact, aside from the market's reaction to the Italian election fiasco and the tax avoidance-inspired activity announced in recent weeks as an outcome of the fiscal cliff tax deal back on 3 January 2013, it's been a pretty boring quarter.
Let's start today's post about where stock prices are headed by retelling an old Indian fable:
Three wise men were blindfolded and led one at a time into a room where an elephant stood. Each was asked to discern what was in the room without removing his blindfold. The first, upon touching the elephant's trunk, concluded a "snake" was in the room. The second, upon contacting a leg, concluded a "tree" was in the room. The third, upon grasping the tail, concluded a "rope" was in the room. All were surprised to discover the elephant once their blindfolds were removed.
We thought it might be fun to illustrate just what the modern equivalent of those three wise men "see" as they attempt to describe what's going on in the stock market with the charts that we've developed over the last several years to analyze stock prices, as described in a recent article from the Reuters news agency.
Odds of a pullback are increasing, with the market in slightly overbought territory, said Bruce Zaro, chief technical strategist at Delta Global Asset Management in Boston.
"I do suspect the closing of the earnings season will lead to at least a pause and possibly a pullback," Zaro said. The S&P 500 could shave 3 to 5 percent between now and early April, he said.
It would seem that Bruce Zaro is a blindfolded wise man who feels the market's potential for mean reversion, such as might happen if volatility in stock prices could be described by statistically normal distribution that might be observed in something that looks like a control chart:
Here, having the most recent data be below the mean trend would suggest a rising market as stocks would be "underbought", while being above the mean trend would suggest that stock prices are "overbought" and are increasingly likely to either stall out or fall in the future.
In this chart, which picks up the major trend that has existed in the U.S. stock market since the QE 2.0 bubble popped in late July 2011, we see that stock prices are in what Bruce Zaro describes as "slightly overbought territory". The 3-5% "shave" he predicts by the end of March would represent a little over a one-standard deviation decline in stock prices, which would be a move from the central black trend line to the light-gray dashed line immediately below it.
Next, let's see what another blindfolded wise man discerns as he examines the stock market:
At the same time, other analysts say, the market has not shown significant signs of slowing, including a break below 15- and 30-day moving averages.
Such moves would be needed to show that momentum is slowing or that the market is at risk of a correction, said Todd Salamone, director of research for Schaeffer's Investment Research in Cincinnati, Ohio. The S&P 500's 14-day moving average is at 1,511 while the 30-day is at 1,494. The index closed Friday at 1,519.
Todd Salamone is what we would describe as a "momentum" guy. Unlike a practitioner of momentum trading, which is really a kind of crowd-following/crowd-anticipating investment strategy, Salamone believes in the physical force of inertia, which is a way of saying that once stock prices get onto a particular trajectory, they'll stay on it!
All you have to do to see that prediction on our chart above is to draw an imaginary line from a point at the bottom of the most recent short-term trend up through the most recent data point for stock prices. And then on out as far as you dare dream. Kind of like Chuck Prince's dance party investment strategy, because what can possibly go wrong so long as you don't see stock prices suddenly dip below the moving line average shown on the chart?...
Let's get one last take on the current state of the stock market from the Reuters article:
The S&P 500 has been trading near five-year highs, and it notched its highest level since November 2007 this week. But the gains have pushed the benchmark index almost as far as it is likely to go in the near term, with strong resistance hovering around 1,525 and 1,540, one analyst said.
As a result, the index is set to move sideways, said Dave Chojnacki, market technician at Street One Financial in Huntington Valley, Pennsylvania. "We just don't have the volume or the catalyst right now" to go above those levels, he said.
Dave Chojnacki is described as a market technician, which means he is a practitioner of technical analysis. Here's how Investopedia explains that black art:
Technical analysts believe that the historical performance of stocks and markets are indications of future performance.
In a shopping mall, a fundamental analyst would go to each store, study the product that was being sold, and then decide whether to buy it or not. By contrast, a technical analyst would sit on a bench in the mall and watch people go into the stores. Disregarding the intrinsic value of the products in the store, the technical analyst's decision would be based on the patterns or activity of people going into each store.
In essence, what he is saying as he senses the stock market today is that because investors have never gone shopping for stocks much above the 1,525 and 1,540 level for the S&P 500 before, they're resistant to go shop for them above that level now.
But then, he goes on to say something actually interesting - he loosely perceives that some sort of physics might be involved, as he doesn't find any forces that might drive stock prices higher as he surveys the market's current environment.
The two comments together would seem to describe how stock prices might behave given the lack of upward room to move that is indicated by the current changes in the growth rates of stock prices and dividends per share driving them as the gap between them narrows in our chart below, if only the analyst knew of the relationship between the two!:
The only perspective that's missing from the Reuters article is the consideration of a steep decline for stock prices once we get past the near term. We guess they couldn't find a fourth wise man to blindfold before going to press....
Starting last year, we began taking snapshots of Standard & Poor's forecasts for where the S&P 500's trailing twelve month earnings per share would be in the future at approximately three-month intervals. Our chart below illustrates how the expected future has changed over time:
Since our last snapshot in November 2012, we find that the earnings for the S&P 500 in the last two quarters of 2012 and the first two quarters of 2013 are now expected to be recorded at levels below where they had been expected three months ago.
But not all is gloomy, as S&P is now projecting a slight increase over previous expectations for earnings in the third and fourth quarters of 2013.
Still, perhaps the most important take-away from our chart though is how different the earnings expected for 2012 (shown as our snapshot of expected future earnings on 17 January 2012) are from where the level at which they are being finalized (shown as our 15 February 2013 snapshot). Going by the S&P 500's estimated total market capitalization of $9.8 trillion in March 2012, the fall in expected earnings for 2012 from January of that year to the present means that over $80 billion worth of earnings expected in 2012 failed to materialize during the year.
We just wonder if today's snapshot of the expectations for earnings in 2013 is as off-target!
Previously on Political Calculations
The previous snapshots we've taken of the way the future looked to investors for the S&P 500 at different points of time are presented in reverse chronological order below:
Prompted by the desire to avoid higher taxes on dividends as part of President Obama's desired tax hikes on investment income in 2013, a record number of U.S. companies acted to pay out record levels of dividends in the final quarter of 2012 [Excel spreadsheet] .
Here is the basic rundown from Standard and Poor's Dividend Action Report [Excel spreadsheet]:
4,002 U.S. companies made announcements regarding their dividend policies in December 2012, a new record. The previous record was 3,716 declarations which was set in December 2011.
483 of these companies announced they would pay an extra, or special, dividend before the end of 2012, also a new record. The previous record of 233 extra dividends paid out in one month was set in December 2007, just as the U.S. economy was entering into recession.
124 companies announced they would increase their regular dividends going forward.
And now for the kicker. In December 2012, 93 U.S. companies announced that they would be cutting their regular dividends going forward, also a new record. The previous record of 81 companies announcing dividend cuts in a single month was set in March 2009, as the U.S. stock market was hitting bottom during the "Great Recession".
Our chart below puts the number of dividend cuts being announced in December 2012 into perspective:
Much of this activity was prompted by the desire of influential investors to avoid higher taxes on dividends, which in the absence of a deal between the U.S. Congress and President Obama, would have meant a top tax rate on dividends of 43.6% in 2013, as opposed to a maximum tax rate of 15% on dividends in 2012. The fiscal cliff deal worked out in the U.S. Senate early in the morning of 1 January 2013 set the maximum tax rates for both dividends and capital gains at 20%, which is further increased by a separate tax increase on investment income of 3.8% as part of the tax hikes mandated by the Patient Protection and Affordable Care Act (aka "ObamaCare"), which then brings the top tax rate on dividends and capital gains up to 23.8%.
The all-time record number of dividend cuts announced in December 2012 represent the outcome of two main forces at work in the economy. First, a large number of U.S. companies have a worsening outlook for their businesses and are acting to preserve their cash flow by reducing their dividend payments to shareholders. Second, a large number of the companies that acted to pay out special dividends before the tax rates on dividends went up on 1 January 2013 have already made the determination that they will be unable to regenerate enough of the funds they were setting aside to pay out dividends at the levels they had originally promised for 2013 from their cash flow and have acted to reduce their dividend payments to shareholders in the future accordingly.
Both factors will put downward pressure on stock prices in 2013, particularly for small and mid-cap companies. Large cap companies like those that make up the S&P 500 will likely fare better, although these companies were not immune from the game of "beat the clock" that was going on in December 2012 for avoiding higher dividend taxes. Our next chart shows the quarterly cash dividends per share for the S&P 500 that have been paid out since the first quarter of 2009, along with the dividends currently expected to be paid out in each quarter in 2013, based upon dividend futures data:
Based on Standard and Poor's estimate of the amount of dividends per share paid out by the companies of the S&P 500 in the fourth quarter of 2012, we now estimate that somewhere between 40 to 60 cents per share was pulled into 2012 from 2013.
Our next chart reveals the downward pressure this action will place upon stock prices in 2013:
It will take a substantial effort on the part of the Federal Reserve's quantitative easing programs to offset the effect of the negative acceleration of dividends upon stock prices in 2013. We don't believe they will be entirely successful.
Our final chart tracks the history of investor expectations for future S&P 500 trailing twelve month dividends per share (you'll have to bear with us for sentences like this one, as we work in the future, but live in the present for the tax advantages. We refer you to Note #1 for further insight into our grammatical choices):
In this chart, we can see the sudden small improvement in investor expectations for the future as a result of the fiscal cliff deal reached on 1 January 2013. We also see a considerable amount of "bunching" between the expected trailing year dividends per share for future quarters, which is an indication of a decelerating economy. A growing economy, by contrast, is indicated by a growing spread between the dividends expected in distant future quarters over time.
On a final note, you can also see that the trailing year dividends expected in 2013-Q4 are riding directly on top of those for 2013-Q3. This is a consequence of the record dividends that are being paid out in 2012-Q4, which add to the trailing year total for 2013-Q3 but not to the total for 2013-Q4.
If not for the tax avoidance behavior associated with the fiscal cliff situation, we would otherwise call that result a clear indication of a dead-on recession. The U.S. economic situation will be better than that appears, but we fear that 2013 will still be characterized by microrecessions, especially in the first and third quarters of the year.
Notes
[1] Yes, we know sentences like that are difficult for many to follow. But as those of us who navigate through the time vortex that is the stock market well know, "tenses are difficult, aren't they?"
Earlier this year, we began taking snapshots of S&P's forecast trailing twelve month earnings per share for the S&P 500 at roughly three month intervals. Our chart below shows how the expected future for earnings has changed over time:
Since our last snapshot in August 2012, the outlook for the expected amount of S&P 500 company earnings has continued to decline, although not as much as the decline from May to August.
Looking at the overlap of historic data and old forecasts, we see that the future vision of investors in December 2010 looking forward to the end of 2012 appears to closely match how things have actually played out over time.
We find that interesting because we would have expected more recent snapshots of the forecast earnings for the S&P 500 to more closely match the actual results than that much older forecast.
The continuing moral of the story: future earnings projections are not necessarily very good indications of actual future earnings. It's simply a good thing that changes in earnings expectations have so little effect upon stock prices or they would be way more volatile!
Previously on Political Calculations
The previous snapshots we've taken of the way the future looked to investors for the S&P 500 at different points of time are presented in reverse chronological order below:
It has been several months since we've featured our chart showing the acceleration, or rather, the change in momentum, of stock prices and dividends per share, including expected future dividends per share, for the S&P 500.
A lot has happened in that time. First, the change in the year-over-year growth rate of stock prices appears to have gone through a spike in August 2012. We say "appears" because this effect wasn't a the result of what we would describe as a "noise event", where investors react, or really overreact, to an event in the news by putting the market though a major swing in stock prices, kind of the way a dog on a leash might react to the sudden sight of a squirrel while being walked.
Instead, stock price volatility, as measured by the VIX, hit a low in August, and has been fairly steady at low levels for the last several months, as the S&P 500's stock prices rose from August to September, where they have been fairly steady since (or at least through the close of business on 22 October 2012).
The spike in our acceleration chart for August 2012 is really the result of how historical data can affect the results of the math behind how stock prices work. Here, our math measures the change in the rate of growth of average stock prices in reference to the year-over-year change in those prices. In going from July 2011 to August 2011, the S&P 500 dropped nearly 200 points to go below 1150, or roughly 15%, and stayed down at that level through September before beginning to rise in October 2011.
Flashing forward in time, since that low level for the S&P now forms the base of reference from which we measure stock prices, we see the result of that even from August and September 2011 as a spike in our chart, even though there has been no actual spike in stock prices during the last several months!
Since we use the information in this chart to project future stock prices (forecasts we stopped making publicly available after December 2011), you might think that dealing with this kind of data artifact would be a showstopper.
It's not really. All we need to do is to choose a different base reference point from which to measure the change in the growth rate of both stock prices and adjust the rest of the math accordingly. We found in playing with the data that all we have to do for the August 2012 spike is to reset the base reference month to be July 2011 - the spike disappears and we can anticipate what stock prices will be from what investors expect for future dividends!
Now that we've really buried the lede in this post for the sake of answering the question "hey, what's that huge spike in stock prices in August 2012?", let's get to the kind of stock market analysis we provide for free today and answer the question "hey, what is going on in the stock market today?"
It's not good news. It appears that investors have shifted their forward-looking focus to the current quarter in setting stock prices today, where they had previously been focused upon the first quarter of 2013. Since the expected change in the growth rate of dividends per share for this quarter is currently negative, the immediate effect of that change in investor focus is that the upward climb of stock prices of the past several months is now stalling out and beginning to reverse.
That's something that will continue until investors either collectively change their focus to another point in time in the future, or if should they remain focused on the current quarter, if the outlook for dividends in this quarter were to suddenly improve. If you're so inclined, you can use the dividend futures data presented in our accelerations chart above to make your own determinations for the future for the U.S. stock market.
As a general rule of thumb, we'll close by observing that it's almost never a good thing when investors focus in on the very near term after having focused on a more distant point of time in the future. The last time we really saw that kind of near-sightedness was during late 2008 and early 2009 when the most-distressed companies in the stock market were acting to slash their dividends, prompting and preceding similar magnitude cuts in stock prices.
We're not saying that's definitively what is in store for the stock market today, but we are wary that part of the federal government's fiscal cliff set by current law to begin on 1 January 2013 is a dividend cliff for investors. We'll have more thoughts on that soon, here (the link will become active some time on 25 October 2012)!
Update 24 October 2012: We wrote this post on 22 October 2012 - what a difference a day makes!
alt="Real GDP vs Climbing Limo and Modified Limo Forecasts, Ending 2013-Q1" style="display: block; width: 600px; margin: 10px auto;" />
alt="Number of Public U.S. Companies Posting Decreasing Dividends, 
