Thursday, May 26, 2011

Are Equities Ahead of Themselves?

The april durable goods report disappointed (i.e missed estimates and down in absolute terms) yesterday. Per the WSJ:
Durable goods orders were down 3.6% in April, compared with expectations of a 2.2% decline. Last month’s gain was revised up to 4.4% from 4.1%.

This is one more piece of evidence lining up on the side of those seeing a slowdown in the second quarter (and maybe beyond). The upward revisions to March’s numbers do ease the sting a touch, but this could bring down some second-quarter GDP forecasts.
I am less concerned with the figure as Japan weighed heavily (and the down month followed a very strong March), but I am concerned that equities are pricing in VERY strong forward expectations. The chart below attempts to segregate durable good results with companies within the industrials sector (industrials aren't a perfect fit, but pretty good). More specific, the chart compares the rolling two-year change in durable goods (new orders) with the industrials equity sector going back to data from 2005.

Part of the reason for the strong performance has been VERY strong earnings driven less by top line revenue growth, but more by widened profit margins from squeezing out costs (i.e. increased productivity through the laying off of workers) and cheap financing for corporates (see below for the huge supply of bonds at the ten year and in portion of the yield curve).

Investment Grade Corporate Bond Universe

Unless durable goods figures spike to the upside in coming months / years, this sector seems awfully ahead of itself.

to Source: Yahoo Finance / Census

1 comment: