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Taxes and corporate profits
A secondary element — when compared to wages, raw materials and interest rates — is the impact of a lower effective tax rate [blue line] on US corporate profits (CP/GDP). Part of the post-GFC fall in the effective corporate tax rate can be attributed to tax losses, incurred during the GFC and used to shield current income. Tax savings are likely to be short-lived, with effective tax rates returning to pre-GFC levels around 24%.
Interest Rates and the Dollar: Not much change
The yield on ten-year Treasury Notes is headed for a test of primary support at 2.50 percent after penetrating the rising trendline. Bearish divergence on 13-week twiggs Momentum strengthens the signal and reversal below zero would warn of a primary down-trend. Breach of 2.50 remains unlikely, but would offer a target of 2.00 percent*.
* Target calculation: 2.50 – ( 3.00 – 2.50 ) = 2.00
Despite falling yields, the Dollar Index is testing resistance at 81.50. Breakout would signal a primary advance to 83.00*. Recovery of 13-week Twiggs Momentum above zero would strengthen the signal. Reversal below 79.70 is less likely, but would warn of another test of support at 79.00.
* Target calculation: 81.5 + ( 81.5 – 80 ) = 83
Wages and corporate profits
Employee Compensation as a percentage of Net Value Added (by US Corporate Business) has fallen sharply since the GFC, boosting corporate profits. Again we can observe an inverse relationship, with corporate profits spiking when compensation rates fall, and vice versa.
A sharp fall in unemployment would send wage rates soaring, as employers bid for scarce labor. But that is not yet on the horizon and we are likely to experience soft wage rates until the economy recovers.
Interest rates and corporate profits
Low interest rates clearly boost corporate profits. The inverse relationship is evident from the strong profits recorded in the 1950s, when corporate bond rates were lower than at present, and also the big hole in profits in the 1980s, when interest rates spiked dramatically during Paul Volcker’s reign at the Fed.
The outlook for inflation is muted and the rise in interest rates likely to be gradual over several years, rather than a sharp spike, if the Fed has its way.
Commodity prices effect on corporate profits
Sharp spikes in the US Industrial Commodities PPI (producer price index) often precede a drop in Corporate Profits (expressed below as a ratio to GDP). And sharp falls in the PPI tend to precipitate a surge in profits.
The 5-year chart above shows PPI growth close to zero since 2012. With wages, raw material costs and interest rates near long-term lows, there is little wonder that corporate profits have surged. The question is: how long will the three remain low? That depends on how fast the global economy recovers. And how long rising demand (from the recovery) is able to withstand rising input costs.
For the chartists: A Long-term View
A long-term view of Corporate Profits/GDP compared to Industrial Commodities PPI shows the relationship is not a perfect inverse, but profits clearly tend to run counter to the rate of PPI growth.
A Mis-Leading Labor Market Indicator | Liberty Street Economics
From a paper by Samuel Kapon and Joseph Tracy at the Federal Reserve Bank of New York:
As the economy recovered and growth resumed, the unemployment rate has fallen to 6.7 percent. …..The employment-population (E/P) ratio frequently is used as an additional labor market measure. The E/P ratio is defined as the number of employed divided by the size of the working-age, noninstitutionalized population. An advantage of the E/P ratio over the unemployment rate is that it is not impacted by discouraged workers who stop looking for employment.
Since the end of the recession, the E/P ratio has largely remained constant—that is, virtually none of the decline in the E/P ratio from the Great Recession has been recovered to date. An implication is that the 7.6 million jobs added since the trough of employment in February 2010 has essentially just kept pace with growth in the working-age population. In its failure to recover, the E/P ratio would seem to depict a much weaker labor market than indicated by the unemployment rate. An important question is whether this is a correct or a misleading characterization of the degree of the labor market recovery…….
Read more at A Mis-Leading Labor Market Indicator – Liberty Street Economics.
Hat tip to Barry Ritholz.
ASX 200 at risk
The ASX 200 is at far greater risk of reverting to a primary down-trend. Retreat of 13-week Twiggs Money Flow below zero, after a bearish divergence, warns of strong selling pressure. Failure of support at 5050 would strengthen the signal, while breach of 5000 would confirm. Respect of the rising trendline is unlikely, but would continue the up-trend.
Breach of support at 5000 would suggest a fall to the long-term trendline, around 4600. Reversal of 13-week Twiggs Momentum below zero again suggests a primary down-trend.
The ASX 200 VIX is rising, but below 20 still reflects low market risk.
Also, none of our macro-economic/volatility indicators indicate elevated risk, but you can’t argue with the tape.
US correction confirmed
The S&P 500 broke support at 1770, confirming a secondary correction. At times like this it pays to look at monthly charts to gain a long-term perspective. The first line of support is at 1700. Respect of the secondary trendline would flag a weak correction indicative of a strong up-trend. Breach of that level, however, would suggest a strong correction to 1550 and the primary trendline. The scale of the bearish divergence on 13-week Twiggs Money Flow, when compared to the divergence in 2007, suggests medium-term selling pressure — typical of a secondary correction rather than a (primary) reversal.
CBOE Volatility Index (VIX) crossed to above 20, suggesting moderate risk, but not yet cause for concern.
The Nasdaq 100 retreated below 3500, warning of a correction. Again, the bearish divergence on 13-week Twiggs Money Flow appears secondary and no threat to the primary up-trend.
Dow scare tactics
I wish I had a dollar for every time the 1929 Dow has been superimposed over the current index. Like this effort at Zero Hedge.
Why did the analyst select a period of two years? Because that is the period that fits.
If we compare the period 1920 to 1933 to the last 13 years, 2001 to 2014, there is a significant difference.
By 1929 the Dow had climbed roughly 400%, while by 2014 the Dow gained roughly 50% over a similar time period.
Superimposing charts one on top of the other has no sound basis in technical analysis and should be viewed as an attempt to scare the market into a sell-off. A correction may be overdue, but there are always potential buyers hoping for much lower prices.
Hat tip to John B. for sending me the Zero Hedge chart.