Equities: the Anti-Gold Investment Stumbles
From its peak in September of 2011, gold has fallen in tandem with rising equities. This inverse relationship has been the norm for decades. Financial assets, especially stocks, rise in an environment that supports confidence and an increasing tolerance of risk. Gold performs well when perceived risks are rising and confidence is shaken.
Equities: the Anti-Gold Investment Stumbles
From its peak in September of 2011, gold has fallen in tandem with rising equities. This inverse relationship has been the norm for decades. Financial assets, especially stocks, rise in an environment that supports confidence and an increasing tolerance of risk. Gold performs well when perceived risks are rising and confidence is shaken.
From 2009 onward, there was increasing confidence that accommodative monetary policy would work, accelerated economic growth was just around the corner and corporate earnings were on the rise. The height of this popular fancy was expressed as TINA, There Is No Alternative, to stocks that is. Any long range investment in gold therefore must take into account the outlook for equities, and that means corporate profits which remain at the heart of most market outlooks.
With virtually 100% of the S&P500 companies now having reported Q4 results, there can be no doubt that profits are heading south with some alacrity. On a GAAP basis, 2015 full year profits per share for the S&P500 companies came in at $86.44. That total is (a) 5% less than the total for the 12 months ending just three months earlier in Q3 2015, and (b) 18.5% below the cycle peak of $106 per share registered for the 12 month period ending in September 2014. This puts the earnings multiple for the S&Ps at an enormously stretched 23.5 and rising as earnings continue to fall.
Moreover, S&P 500 per share earnings have been bolstered by more than $2 trillion of stock buybacks since 2009, meaning that the share count has declined by at least 15% or more. Nonetheless, 2015 per share profits are barely higher than the June, 2007 peak of $84.92 recorded just before the great recession began.
But these are not the numbers put before the investing public day after day. As an excellent Wall Street Journal investigation showed recently, Wall Street's version of pro forma earnings (ex-items) for the S&Ps in 2015 came in at $1.040 trillion, fully 32% higher than actual GAAP earnings of $787 billion.
The $253 billion difference between pro-forma and GAAP earnings in 2015 supposedly comes from so-called non-recurring items — asset write-offs, plant shutdowns, store closing costs, goodwill reductions, restructuring charges and stock options costs — that investors are told to ignore. Therefore, the argument that the market is not overpriced. But as we saw in 2008, non-GAAP earnings do not pay the bills or service the deb. In a downturn, they vaporize.
Using GAAP earnings, the downtrend is clear in the chart above. Furthermore, FactSet has estimated that another 8.3% decline is likely in Q1 of this year. If the index reports a decline in earnings for Q1, it will mark the first time it has suffered four consecutive quarters of year-over-year declines in earnings since Q4 2008 through Q3 2009. This level of performance has always signalled a recession in the past.
We expect that pre-announcements will be heavy in the weeks immediately ahead and earnings projections for the rest of the year will be reduced aggressively. It already started last week with Caterpillar and Tiffany announcing huge, 'unexpected' markdowns in their estimates. In our view, the downward sloping earnings trend for corporate America is the gold bull market's dirty secret: as equities lose their appeal, gold will rise once again.