Earnings, Margins, Interest Rates And Regulations

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By: Kent Engelke | Capitol Securities

Many are suggesting equity averages will decline in the immediacy, a decline anywhere from 5% to 25%. The reasons are varied including the election, the President publically criticizing the Fed, trade, peak in earnings/margins and interest rates to name a few.

Commenting about earnings according to S & P, earnings per share in the index rose by 6% q/q in Q2 with a record high 79% of firms in the index beating analysts’ estimates. Unexpectedly strong sales growth contributed and operating margins also climbed to their highest since data began, helped by tax reform.

I think margins will begin to erode but not because of a slowing economy. I think growth will continue to accelerate which will increase pricing pressures and interest rates. Many believe the economy will slow because of trade given that 44% of sales for the companies in the S & P 500 are the result of trade according to the S & P. More foreign sales are made in Asia than any other region.

Global economic growth has accelerated as the multipolar interdependent world is collapsing, the inverse of expectations. All must remember most economists thought global growth would soar via interdependency and massive fiscal/monetary stimulus. Growth sputtered and is a major reason for the economic nationalist movement that is now sweeping western democracies.

Because of a reduction in taxes and regulation, as well as rising home prices, I believe the supply side of the economy is now being stimulated for the first time since the early 1980s and late 1990s, the previous eras of strong 4% plus GDP growth. This growth will impact margins, hence valuations of the highest PE companies.

Speaking of regulation, Microsoft joined Facebook in calling for regulation of technology and social media companies. Wow! This is the first time that I am aware of industry leaders being asked to be regulated.

Is the result that these companies have become too powerful and their technology will be used against society?

China has launched a “social credit score” on its 1.4 billion citizens, a score generated via algorithms mining information from social media and other sources. A spokesman for the General Secretary of the Central Committee stated: “Running the plan as deeply as possible to determine how to allocate benefits and also how to impact and shape society’s behavior is the objective of this program.”

Wow! To me this is frightening and I ask what will keep our government or bureaucratic organizations from doing the same? In many regards, it is already occurring.

By definition, regulation stifles growth and profitability. As commented a gazillion times, equity ownership is focused in a handful of mega-sized technology/social media firms. In my view, these companies are already greatly overpriced. Higher interest rates and greater regulation will impact margins hence values.

Perhaps the concerns echoed by many about an impending decline in averages are of considerable validity.

Last night the foreign markets were up. London was up 0.36%, Paris was up 0.42% and Frankfurt was up 0.22%. China was down 0.70%, Japan was up 0.64% and Hang Sang was up 0.63%.

The Dow should open nominally lower as all attempt to gauge the fallout from the latest legal drama surrounding the Trump presidency. The 10-year is up 2/32 to yield 2.83%.

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