Weekly Report
Artem Karida
Educator | C-suite advisor | business strategy, innovation, and marketing expert
Week 47. November 21 - November 27, 2022
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Analytics
S&P500 earnings 2022 major insights
The S&P500 earnings season is concluded. What have America's largest firms demonstrated?
Operating profit is still in positive territory in 3Q 2022, although this is the fifth quarter in a row that it has decreased (in 2Q 2021, there was an increase of 89% yoy due to the low base effect of the COVID collapse). Operating profit rose by 11.6% y/y in Q1 2022, by 9.8% y/y in Q2 2022, and 3.7% in Q3 2022 and is expected to rise by 1.4% y/y in Q4 2022 according to industry analysts and investment banks.
Positive expectations are deteriorating in front of our eyes. Back in July 2022, Wall Street predicted operating profit growth for the Q3 of 2022 to be 11%, and for the Q4 of 2022 to be 13-14%. In September, expectations were reduced to 5 and 8.5%, respectively, with an adjustment closer to reality to 2-4% and 3-4% by the end of the year.
In the recent week, another drop in operating profit projections to a paltry 1.4% y/y in 4Q amid pessimistic corporate forecasts about future growth prospects. There is every reason to anticipate that the fourth quarter will be negative.
In reality, oil and gas contributed 8.6 percentage points to profit growth, implying that excluding oil and gas, the reduction in operating profit for S&P500 businesses is more than 5%!
Revenue is increasing at an 11.6% year-on-year rate, which has been dropping for four quarters in a row but is still fairly strong by historical standards. In this case, two elements are important: inflation and oil and gas prices. Companies in the energy industry generated 3.4 per cent of overall revenue growth in Q3 2022, this was less than the record positive contribution of 5 per cent in Q2 2022.
Thus, while an 8.2% revenue increase excluding oil and gas appears to be significant when adjusted for inflation, it equals zero.?
From Q2 2022, there has been a significant reversal and decline in operating indicators. By 13-14% in September, expectations fell to 5 and 8.5%, respectively, with an adjustment closer to reality to 2-4% and 3-4% at the end of the year in the time of corporate reports for the third quarter.
The primary engines of American industry
American businesses are losing steam. The primary drivers of growth, accounting for more than 70% of the total revenue growth of S&P 500 companies from Q3 2021 to Q2 2022, were information companies (Information Technology sector), healthcare companies (Health Care sector), and consumer companies (Consumer Staples and Consumer Discretionary) supported by the financial sector (Financials).
From Q3 2021, commodity companies, primarily the metallurgical complex (Materials), oil and gas, and utilities (Utilities), were able to take the lead, supported by consumer companies. However, these industries are also losing ground as average quarterly raw material prices fall. The positive dynamics are attributable to the effect of the base of comparison, when raw materials were very inexpensive in Q2-Q3 2021, particularly oil and gas, but for metallurgical firms, revenue dynamics drop to zero in Q3 2022 and will turn negative in Q4 2022.
Due to extraordinarily high prices, oil and gas corporations will keep the "flame" lit until the end of 2022, but 2023 will be difficult with obviously negative dynamics.
Consumer companies are rising as a result of inflation and consumer excitement in 2020-2021, and in 2022 as a result of lowering the savings rate to historic lows and an extraordinary credit boom. This will all come to an end in 2023.
Because the cost of funding grows far more slowly than the cost of lending, the financial sector is in the black as a result of the credit boom of businesses and the population, with the transfer of costs to borrowers.
As emergency medical programs are curtailed and the primary phase of active digitalization of the economy based on the principle of remote work is exhausted, the information sector and biotech, the main beneficiaries/lobbyists of the COVID crisis/lockdowns, are sharply losing revenue growth rates. By the way, one should not be surprised by the reactivation of work in this area and the next "initiatives" for the welfare of people and the globe.
The military-industrial complex, which is part of Industrials, is now the new drive for expansion, although its scale is insufficient to stretch the entire economy.
Profitability analysis of key industries of the American economy
Profit trends in the United States are consistently negative.
Inadequate forecasting
On operational indications, the market lowers its projections and expectations for 2023. The fundamental craziness, though, is that neither politicians, industry analysts, company executives, nor bidders consider the crisis in 2023 to be the base case.
When we compare the earnings and operational profitability of American companies to actual reporting and estimates, a surprising picture emerges.
If you have worked as we did in the field of forecasting for individual industries or the economy in general, you should be familiar with the following principle: "Always overstate projections as much as possible to establish inadequate market expectations and expedite capitalisation, and then rectify in line with real results with the poker face". This has always been the case, with the exception of 2018, 2021, and 2022. Trump's tax reforms intervened in 2018, helicopter money in 2021, and inflation in 2022.
However, the market reduces revenues expectations for 2023 from 6% to 2-3%, predicting stagnation rather than a crisis. At the same time, financial system players predict that earnings in 2023 will be 5% more than in 2022 and will expand by 10% more year on year in 2024. All of this is bordering on ridiculous.
It is worth noting that Wall Street experts and most known think tanks have not anticipated a single catastrophe in history, at least since 1985, when they began keeping track of their work.
So, any rational and responsible manager has at the very least disregard the forecasts of all known institutes and think tanks.?
Operating profit margins in the United States
Operating profit margins in the United States have fallen to 12.7% from an average of 12% in 2019, and 13.9% recorded in the second quarter of 2021.
It is no longer possible to transfer costs to customers and counterparties by raising prices. Costs are now increasing faster than prices.
Historically, the equilibrium level of marginality was thought to be 10-11% from 2012 to 2017, and since 2018, technology corporations have begun to accelerate, greatly distorting overall statistics of business efficiency, while business without IT as a whole has had little transformed efficiency over the last 5-10 years, with the exception of oil and gas, which is posting record profits.
Margin contraction is exactly what should have happened in the midst of an inflationary crisis. Intra-industry, inter-sectoral, and cross-country competition is increasing, and costs are eroding across the board. The same thing is happening in Europe, sometimes even more intensely.
Financial market decline
In the most capacious, liquid, and capitalised market (the United States), the drop from high to low?was 25.4%. The high was on January 3, 2022 (4796 S&P 500 points), and the low was on October 12, 2022 (3577) - a 282-day journey.
There have been six episodes of a larger decline on markets over the last 50 years:
The market collapsed five times during a crisis: the inflationary crisis of the 1970s and 1980s (with the exception of 1987), a recession associated with the business cycle and the collapse of the dot-com bubble at the beginning of the twenty-first century, the well-known global financial-economic crisis of 2008-2009, and the COVID crisis 2020, flooded from top to bottom with liquidity.
Given the context of the situation, geopolitical conditions, financial and economic factors, the 2023 crisis is unavoidable; thus, the matter will not be resolved in 282 days, to be continued.
Current account of the Eurozone
The Eurozone countries' current accounts have been in a consistent deficit for seven months in a row. The decline began in October 2021, following the rising energy prices, although the switch to a deficit happened only in March 2022.
The accumulated deficit is 98.5 billion euros from March to September 2022, compared to a surplus of 180.8 billion euros in 2021 (March-September), a surplus of 88.2 billion euros in 2020, over 164 billion euros in 2019, and 205 billion euros in 2018.
A 300 billion euro gap emerged in just seven months (transition from a surplus of 200 billion to a deficit of 100 billion euro).
Unlike the trade balance, which establishes an anti-record, the current account was relatively equivalent to the current account in 2008. The current account deficit was 88 billion euros from March to September 2008, while the worst 12-month period was from January to December 2008, with a deficit of 180 billion euros.
In 2008, a 60% deficit was created as a result of a large excess of investment payments over revenue, i.e. Eurozone countries spent more in interest, dividends, and reinvested money overseas than they received in accordance with assets/liabilities and returns.
In 2022, the trade balance (in goods) drives the current account deficit entirely, while the investment balance is positive. The energy balance contributes the most to the structure of the trade balance deficit.
Why is it significant? A current account deficit necessitates a net inflow of external capital, but the difficulty is that on interest rate differentials, in current economic and geopolitical conditions, in a competitive comparison, the Eurozone members are bound to lose to any other currency region.
When given the choice between euros and dollars, foreign capital will undoubtedly favour the latter. While Europe was in surplus, this was not a concern; nevertheless, Europe now requires an injection of money. Covering currency gaps causes problems because it puts pressure on the euro, undermines financial stability, and disrupts cross-border capital flows.
Full-fledged energy crisis
OECD countries spend 18% of their GDP on energy. This is near to the highest level in history, breaking the 1981 anti-record. A balanced level of energy spending that promotes the economy's potential to develop and diversify is 9-10% of GDP.
Unlike the 1970s energy crisis, the main negative impact in 2022 was from rising gas and electricity prices. During the 1974 energy crisis, energy costs grew by 8.6 percentage points, with oil accounting for 6.5 percentage points of the rise. or about 34% of the total expenditures
During the crisis in 2022, spending growth was 7.8 percent more than in 2021, with oil contributing 2.4 percent, 1.86 percent, and electricity 2.54 percent.
Energy is an important resource in the economy. Rising prices diminish output, causing secondary inflationary pressures by reducing the supply of products and services. It also reduces household purchasing power by distorting demand structure and pushing out spending on other goods and services, as energy is primary. This will eventually lead to a crisis characterised by cascading production shutdowns and a closed loop of demand decrease. The magnitude of the shock is unprecedented in 100 years.
Russian gas substitution in Europe
From January 1 to November 20, 2022, cumulative gas deliveries to Europe from all routes and sources (pipe + LNG) declined by a symbolic 1.3% year on year.
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Gas imports and consumption are always higher in the winter. They now supply 7.5 billion cubic meters per week, down from 9-9.5 billion at its peak in winter 2021. If supplies from Gazprom are not increased, the maximum for increasing imports from all sources is 8 billion, i.e. a weekly shortfall of 1.2-1.7 billion cubic meters at the peak in winter, which produces an accumulated deficit of 20-22 billion cubic meters throughout the heating season.
This can be mitigated by a 10% decrease in usage, ensuring that no one gets cold.
Of course, another point is the prices are expensive - almost 350 billion euros more than in 2021. However, we should not bet on the long-term sustainability of the current (high) gas price. As energy flows normalise, the primary suppliers and domestic demand will adjust, lowering the mark-up of geopolitical risks and supply uncertainty that is currently incorporated in gas prices.
Trade relations with Russia
The EU and the US intend to impose a price restriction on oil with Russian supplies. In exchange, Russia guarantees not to supply oil to countries that have set price controls on crude oil.
According to Bruegel, any business relations between the United States and Russia on energy carriers have been fully cut off since May, with no more transactions passing. Prior to that, in 2021, the United States supplied and got $17.4 billion in the field of oil and oil products. Russian losses from commercial contracts with the United States are anticipated to be $27-28 billion in 2022.
Since June 2022, the United Kingdom has been halted all trade with Russia. In 2021, the overall amount of trading for all positions was $7 billion, with oil and oil products accounting for $5.5 billion and gas accounting for $1.5 billion.
The EU countries' attitude is radically different - trade continues. In 2021, Europe paid 121.4 billion euros for all positions (coal - 6.6 billion, oil & oil products - 87 billion, gas - 28 billion). In 2022, the EU has already transferred 129 billion euros in the first nine months, with coal accounting for 6.6 billion (fully halted in September), oil accounting for 81 billion, and gas 41 billion dollars.
There has been a visible recovery in Russian gas import in monetary terms since June, despite a 4-6-fold decline in physical terms. The prices were actively climbing until September, which indirectly validates the market nature of the pricing of contracts in 2022. Pipe & LNG from Russia have an average monthly costs of 4.7 billion euros in August-September, up from 2.4 billion euros the previous year.
Total paid amount from all EU nations were 11 billion in September, compared to 12.7 billion in 2021.
PMI Eurozone
According to the S&P PMI, business activity in the Eurozone fell for the fifth month in a row in November. Including the short-term effect of the COVID, the rate of fall remains the second highest since 2013.
The PMI is a leading indicator that reflects the dynamics of economic activity and has a high correlation with real GDP data. A reduction for five straight months earlier resulted in a decrease in GDP in 100% of cases; thus, negative GDP dynamics are unavoidable in the fourth quarter of 2022.
The magnitude of the PMI reduction corresponds to a 0.5% qoq loss in GDP in Q4 2022 and a 2% y/y drop.
The weakening of inflationary pressures reduced the rate of drop in the Eurozone PMI in November. On a monthly basis, business costs climbed at the slowest rate in 14 months, but inflation remained at a record high and will remain at a record high in 2023.
Production has fallen for six months in a row, and services have fallen for four months in a row at the quickest rate in ten years (excluding COVID crisis). The chemical industry, metallurgy, and the production of plastic and rubber products have experienced the greatest drop, which is directly tied to unacceptable energy costs.
Furthermore, business observes a decline in the quality of labor resources, an increase in the cost of capital, weak export orders, significant economic uncertainty, and the major issue, inflation.
Only the extension of supply chains and the normalisation of logistics, which has been an issue for two years, are beneficial.
The real money supply (M2) in the United States
The real money supply (M2) in the United States is contracting at an inflation-adjusted rate of 6% per year, the most since April 1980, when the money supply contracted at a record 6.5% per year. Typically, the peak of inflation occurs at the period of greatest decline of the real money supply, as was the case during the 1970s and 1980s inflationary crisis.
What factors should be considered here?
That is why, unlike the 1970s and 1980s, the peak of inflation and the highest rates of money supply contraction might be out of sync, as evidenced by the costs of goods and services, which have not yet begun the period of decline. Previously, a contraction in the money supply in real terms resulted in a drop in spending; currently, it does not.
Because of the deformation of feedbacks and changes in the structure of the financial system, economic laws do not work as well as they used to, hence inflation can remain high despite a fall in M2.
Why is the Christmas rally more harmful than beneficial?
Due to a record for a decade of market growth and a strong decline of the dollar, the global stock market's capitalisation was restored from October 12, 2022 to November 24, 2022 (an increase of over 22%, from 89 trillion to 108 trillion).
The situation is worse in China and the United States (thanks primarily to technology businesses), while European indexes are rebounding to all-time highs in par and April levels in dollar terms.
The growth rate of European indexes at par was 14-18%, and about 9% must be added to this thanks to strengthening euro.
Such expansion has occurred only five times in the last 25 years.?Twice in 2020, following a post-COVID monetary shock, with indexes recovering from lows between June and December 2020, and three times during the 2008-2009 financial crisis (January 2009, April 2009, August 2009).
All episodes of 22-25% capitalisation growth in dollar terms over 1.5 months occurred during the aggressive monetary and fiscal pumping phases in 2009 and 2020, but nothing like it has ever occurred on the trajectory of aggressive tightening of monetary policy and entering the next stage of the debt crisis.
All of this merely underlines the markets' insanity. The present capitalisation is compared to the average capitalisation (from October to December 2021) and the maximum values at the start of 2022.
The UK is above the October-December 2021 average, as are India and Brazil, with France, Japan, and Australia trailing by a few percentage points. China has its own history, and in the United States, the fall of technology businesses drove through the NASDAQ and S&P, while "value" companies are still trading at pre-crisis levels.
It must be understood that the capitalisation levels recorded in 2021 are in the context of the strongest bubble in 100 years, with entirely disabled feedback in an era of cheap and unlimited liquidity, with faith in the "perpetual motion machine," when you can create money from the air without consequences.
Now that a new era has arrived, phantom pangs bring back memories of a carefree and irresponsible monetary frenzy.
With the exception of technical oversold, particularly poor sentiment in October, and seasonality in November-December, one of the explanations is the collapse of the world's central banks' transmission mechanism.
Excess liquidity has kept deposit rates at zero and has prevented them from climbing in tandem with major rate hikes and bond yields. We have already explored these processes in detail using the United States as an example.
This is causing liquidity to flow out of money markets and into debt markets (thus the strongest debt rally in 20 years and falling yields since October) and risk assets (the biggest market rally in 25 years since October).
So, is it positive or negative? World Central Banks will soon worry because credit is increasing, consumption is not declining, assets are on the nuclear pump, and inflation remains at an all-time high. Their monetary policy is ineffective, and all laws and regulations have been discarded.
Failing industry
When it comes to the largest, most liquid, and most capitalised equity market in the world (US), all of the deterioration in 2022 is being driven by a few tech businesses.
From December 31, 2021 to November 24, 2022, the value of all public American corporations (about 4,620 issuers) fell by 18.3%, or $9.2 trillion, however the harm was concentrated in only 8 sectors out of 20:
As a result, the aggregate result for all other sectors (12 types) was negative, while 5 sectors were positive, with two leaders - oil and gas (plus $721 billion) and industrial and technical services (+126 billion).
- Among the 4,620 companies, the top decliners (50 companies) represented more than 72% of the total decline (6.7 trillion out of a 9.2 trillion drop in 2022). These 50 corporations have a combined capitalisation of $12.8 trillion, accounting for 31% of the total.
Top 100 losers (37.4% of total capitalisation) - this is 8 trillion, or nearly 87% of the total fall in market value.
In 2022, slightly more than 200 companies (46.6% of market capitalisation) created ALL market capitalisation declines, implying that the other more than 4,400 companies had no capitalisation change.
The biggest negative effect felt by the growth leaders of 2020-2021, as well as all the so-called "success stories" with completely unrealistic expectations and multipliers.
Global capitalization of public firms by country
The global capitalisation is predicted to be $102.1 trillion as of November 26, 2022, based on a sample of over 45 thousand enterprises from throughout the world (calculations based on the TradingView database). The sample was cleansed of ETFs, depositary receipts, and other surrogates to avoid multiple recalculations, as businesses can meet 4-5 times when consolidated from several exchanges (especially European ones).
The top ten countries are as follows:
(Italy ranks 21st with 0.6 trillion.)
Surprisingly, among all major countries, American and Chinese markets exhibit weak year-on-year change dynamics, whilst European markets exhibit higher volatility.
In the following report, we will provide further information on this topic.
Amusing statistics facts
THE END OF THE REPORT
Stay tuned.?
Regards, Negorbis.
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