Amid the turmoil in the emerging markets, Societe Generale strategist Albert Edwards is as bearish as ever.
“Our warnings throughout last year that an unravelling of emerging markets (EM) was the final tweet of the canary in the coal mine have still not been taken on board,” he wrote in a new 6-page note to clients. “The ongoing EM debacle will be less contained than sub-prime ultimately proved to be. The simple fact is that US and global profits growth has now reached a tipping point and the unfolding EM crisis will push global profits and thereafter the global economy back into deep recession.”
Profits and profit expectations are ultimate what drive stock prices. And the worry is that fragile and weak profit growth is about to make a big turn for the worse.
“One thing [SocGen’s Andrew Lapthorne] has been highlighting for some months is just how incredibly anaemic profits growth has been in both the developed and emerging markets, the latter being particularly poor having contracted for the past two years,” wrote Edwards.
The widely followed measure of profit growth are adjusted or pro-forma, which often has the affect of boosting earnings. However, even these numbers don’t look good. Check out this chart:
Edwards pointed to this quote from Lapthorne:
Of course even these MSCI figures have been flattered by a reduction in the share count plus lower interest rates and tax charges. If we look at overall growth in earnings before interest and tax, or indeed gross cash flow, we find that neither has really moved for the last couple of years. It would appear then, that at an aggregate level, most profit growth is the result of astute financial engineering rather than improving cash flow — yet another sign of a tired, long in the tooth, profit cycle.
No one will dispute the fact that earnings per share growth has benefitted from low share counts, interest rates and tax rates. The bullish take on this is that interest and tax rates will stay low for a long time. Furthermore, cash rich companies will continue to buyback shares.
However, a decline in overseas profits would be trouble for U.S. stocks as these companies generate around half of their revenue abroad.
“The dire profits situation will only get worse as EM implodes and waves of deflation flow from Asia to overwhelm the fragile situation in the US and Europe,” wrote Edwards.
Meanwhile, all of this comes as the Federal Reserve tapers its stimulative quantitative easing program, which many agree is putting increasing amounts of pressure on the EMs.
It’s worth noting that Edwards has been bearish during this entire multi-year stock market rally. But we can’t help but admire his stick-to-it-tiveness.
“And even if the Fed resumes massive QE at some point as the world melts down, and markets desperately attempt their return to the dream trance, they will instead find themselves locked into a Freddie Kruger-like nightmare in which phase 3 of this secular bear market takes equity valuations down to levels not seen for a generation,” closed Edwards.