Corporate CEOs are right on the front line, interfacing directly and indirectly with consumers and suppliers. Unlike economists, strategists and analysts who deal with data weeks and months old and often revised, CEOs know first hand what’s happening at this very moment. They see and feel what’s about to hit them.
The Conference Board Measure of CEO Confidence™, which was unchanged at 43 in the second quarter of 2019, declined to a reading of 34 in the third quarter (a reading of more than 50 points reflects more positive than negative responses). This is the lowest reading since Q1 2009 when the Measure was at 30. (…) In a separate poll of CEOs and CFOs (conducted in September), we found that a large majority believe the recent trade disputes will have a lasting impact on their business.
CEOs have grown more pessimistic about current economic conditions, with only 8 percent saying conditions are better compared to six months ago, down from 13 percent last quarter. Close to three-quarters say conditions are worse, up from 42 percent in Q2. CEOs were also more negative about current conditions in their own industries compared to six months ago. Currently, only 15 percent say conditions are better, down from 21 percent last quarter. Close to two-thirds say conditions are worse, up from about one-third in Q2.
Looking ahead, CEOs’ expectations regarding the economic outlook deteriorated further. Now, just 4 percent anticipate economic conditions will improve over the next six months, down from 13 percent in the second quarter. Meanwhile, 67 percent expect economic conditions will worsen, up from 44 percent last quarter. CEOs’ expectations regarding short-term prospects in their own industries over the next six months were also more pessimistic. Now, only 13 percent anticipate an improvement in conditions, down from 17 percent last quarter. Those expecting conditions will worsen in the short-term rose from 38 percent last quarter to 56 percent in Q3.
Scary stuff if you ask me. Superimposed on the bleak PMI surveys of purchasing managers (interfacing directly with sales and production to manage inventories), investors should be particularly wary given the most recent surveys of corporate officers.
I have done several thousands management interviews in my 35-year professional career and corporate officers are rarely downbeat about their outlook. This chart from Lance Roberts shows that at current levels on the CEO Confidence Index, we are near or in recession. Keep in mind that recessions are always officially dated after the fact. It was only in December 2008 that we learned that the recession actually started in December 2007.
The feeling on the front line has deteriorated big time this summer:
- Close to 75% of CEOs say economic conditions are worse, up from 42% in Q2. 67% expect conditions will get even worse, up from 44% last quarter.
- Close to 66% say conditions within their industries are worse, up from about 33% and 56% think things will get worse, up from 38%.
CEOs’ assessment of current conditions “declined sharply for China and Europe, and to a lesser degree for the U.S.” but “CEOs are considerably more pessimistic about short-term growth prospects in the US, China and Europe.”
Sixty-three percent of CEOs and CFOs say their business has been, or will be, impacted by the U.S.-China trade dispute, according to a separate poll conducted by The Conference Board in late September.
The most anticipated outcomes, according to 64 percent of respondents, are negative impacts to both sales and profits. More than half of those surveyed expect upward pressure on costs. One-third say they already have, or plan to, pass along price increases to their customers.
Tariffs, by definition, raise purchase costs. These either are passed along down the line or absorbed in reduced margins. The binary outcomes are both bad for profits.
Duke University conducted its own survey of corporate CFOs from Aug. 27 to Sept. 13 with 500 CFOs, including 247 from North America, 54 from Asia, 67 from Europe, 127 from Latin America and 37 from Africa.
- 55% of CFOs have become more pessimistic compared to the 2nd quarter this year, far outnumbering the 12% who say they have become more optimistic. (…)
- Optimism in the U.S. is 63 on a scale of 0 to 100. Optimism is lower in all other regions: Europe (59), Asia (51), Latin America (41) and Africa (39).
- 53% (48% last June) of U.S. CFOs believe that the U.S. will be in an economic recession by the third quarter of 2020, and 67 percent predict a recession by the end of 2020.
“For the first time in a decade, no region of the world appears to be on solid enough economic footing to be the engine that pulls the global economy upward,” Graham said. “Trade wars and broad economic uncertainty are hurting economic outlooks worldwide.”
We know that uncertainty has frozen corporate capex, already being curbed to near zero growth globally. This is having a cascading effect. “That has had a disproportionate impact on the metals market where demand is currently heading for its worst year since 2009. On our estimates, global demand for zinc, aluminum and copper is contracting this year.” Goldman Sachs also notes that “last month global economic policy uncertainty notched its highest reading in at least 20 years.” After the 2012 spike in policy uncertainty, global capex growth sank from 8% to 4%.
Corporate buybacks, driven by CEOs and CFOs, are also being pared down as a result, limiting one of the major demand components for U.S. equities. BCA Research illustrates the correlation:
The National Federation Of Independent Business polls its approximate 1700 small biz members monthly. These fellows got highly optimistic following Donald Trump election boosting their Outlook measure to a 50 all-time high in December 2016. It is now 9, which is the high end of the 2009-2016 range when sales and earnings were well below average. Small biz are the main drivers of employment in the U.S..
Lance Roberts contrasts the CEO Confidence Survey with Consumer Confidence Surveys. Here’s the most interesting part of his analysis:
Another way to analyze confidence data is to look at the consumer expectations index minus the current situation index in the consumer confidence report.
This measure also is signaling a recession is coming. The differential between expectations and the current situation, as you can see below, is worse than the last cycle, and only slightly higher than prior to the “dot.com” crash. Recessions start after this indicator bottoms, which has already started happening. (…)
Note, bear markets end when the negative deviation reverses back to positive.
But, one might say, where’s the bear? We could be unknowingly in recession but equity markets are notorious bear sniffers. Schwab’s Liz Ann Sonders might have part of the answer:
Since January 26, 2018, nearly every major global index has experienced a bear market at some point; and some have failed to come back to their prior highs. You can see from the table below that U.S. large-cap and technology stocks have eked out positive gains up until now, but U.S. small-cap and international stocks have been left behind; along with the Value Line Arithmetic Index, which includes 1,700 stocks and represents a broader swath of the U.S. stock market:
One of the remarkable features of this equity bull cycle is the lack of participation, declining volume and the absence of euphoria that often pushes valuations to extremes and signals a peak:
Another remarkable feature is that, based on Goldman Sachs data, corporate demand for U.S. equities accounted for 74% of total demand for U.S. equities since 2015 and was never less than 49% which, by the way, is the number for the first 6 months of 2019.
While market caps were exploding 3.5 times since the 2009 low, corporate buybacks kept gobbling between 3.0% and 3.5% of the S&P 500 market cap. Given the continuous decline in the available number of shares, buybacks have been bidding up a constantly declining pool of shares.
S&P 500 companies suddenly decided to markedly reduce buybacks in Q2’19 following the tax reform-induced surge of 2018. Non-S&P 500 companies had already started to curb buybacks.
The plain truth is that corporations cannot prudently sustain buybacks at their recent high levels:
Economy wide pretax profits peaked in 2014 and are now 9.9% below their Q3’14 level (-3.0% after tax thanks to the tax reform). S&P 500 quarterly profits peaked in Q3’18 and are now rolling over on a trailing 12-months basis.
More significantly, Goldman Sachs reports that
Non-financial S&P 500 cash balances have declined by $185 billion during the past 12 months, representing the largest percentage decline since at least 1980 (-11%). At the same time, debt levels have inflected higher; S&P 500 firms increased debt levels by $410 billion (+9%). The uncertainty surrounding the outcome of the 2020 US presidential election and its potential implications for policy will likely lead corporate managers to adopt a wait-and-see approach to cash spending. A similar trend occurred around the 2016 presidential election, when annual gross buybacks fell by 5% excluding Energy. YTD buyback authorizations have declined by 17% year/year, which leaves firms less dry powder to execute buybacks than in prior years. (…)
Corporate equity demand during the first half of 2019 was 25% lower than the same period last year. Early 3Q earnings results show that gross buyback activity was also weak last quarter.
Goldman expects that buybacks will decline 5% in 2020 which would reduce net corporate purchases of US stocks by 2% to $470 billion. But that may prove optimistic. Share repurchases are down 7% in the first half but fell by 18% YoY in 2Q. Through October 15, buyback authorizations are down 17% YoY. Given the rolling over of profits, the recent sharp declines in CEO and CFO confidence measures, the uncertainty regarding the trade wars and its lingering impact and the impeachment process during an election year, it would seem prudent for corporate officers to build cash reserves or reduce debt.
TrimTabs Research last Friday noted that there has been a “massive decline in #buyback announcements: number and volume of buybacks in #earnings season plummet to lowest levels since 2009.”
The risk is thus that the main source of demand for U.S. equities will take a break until a better outlook shapes up, which could well be after November 2020 unless Xi and Trump find a way to settle the war without totally losing their already pretty bruised faces.
Lowry’s Research says that the market advance since June resulted from a decline in Selling Pressure while Buying Power has remained stable at a low level. This chart shows that, amid a rising market, total volume remains in a downtrend.
U.S. households bought $313 billion of U.S. equities in the first half of 2019 (annualized per GS). In the 5 years to 2018, they had bought a grand total of $10B. Does that sound like euphoria?
It could well be, however, that this time around, euphoria is living in a less obvious place: private equity where deal values keep rising…
…in spite of purchase price multiples way above previous peaks…
…in spite of excessive leverage…
…induced by too much money chasing deals amid rock bottom interest rates (charts from Bain and PitchBook):
Likely related from Fortune’s Polina Marinova::
DIALING DOWN THE RISK: I’ve written before how the most shocking thing in the whole SoftBank/WeWork saga is that risk-loving Masayoshi Son is changing his tune when speaking to founders. He famously told WeWork CEO Adam Neumann that he appreciated how he was crazy—but thought that he needed to be crazier. “Recently, I’ve been telling founders to ‘know your limit,’” Son said in an interview earlier this month. “Knowing your limitations will help unleash limitless possibilities.” [
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Now, the Wall Street Journal reports that SoftBank’s aggressive, high-risk strategy is changing, and the firm will focus “more on improving corporate governance at portfolio companies.” Under the lower-risk strategy being imposed by Son, the fund already is being more careful about proposed deals it might otherwise have done quickly, according to the report. Son has recently asked for more information from his investment team before pulling the trigger on some deals.
Stephen Schwarzman, CEO, The Blackstone Group:
…investors are now taking a closer look at underlying business models, particularly in the equity markets businesses that do not have a near-term path to profitability and consume a lot of capital are facing headwinds. (…) the idea you can sort of show up with the business and say, hey look, I’ll start making money six or seven years from now that’s becoming increasingly difficult. And I think for market participants, that’s a healthy sign.
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