Issue: 262
Sent: 03-05-2011 11:38:06
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Tipping Points: Profits and CurrencyA How To Book Of Self Managed Super FundsFoFA Mark II
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Tipping Points: Profits and Currency

Click here to buy - A How To Book of SMSF's by Tony Negline
John Robertson

The direction of corporate profits and the US dollar are at critical points. Soon, we learn about the future direction of a range of financial markets.

There are two charts at The first shows the quarterly history of US corporate profits since 1988. The yellow line is the after tax profit series reported in the national accounts by the US Bureau of Economic Analysis. The blue line is the better known earnings series of S&P 500 companies. The red markers are analysts' forecasts for the S&P 500 companies over the coming two years.

Both profit series highlight the same three visually striking features.

The critical question now is 'where to from here?'. Extrapolating the most recent experience might suggest a lacklustre outcome over the coming year. The bottom up earnings forecasts from the stock analysts, on the other hand, are suggesting that recovery will gave way to an earnings expansion that would validate a continuing rise in US equity prices.

The second chart shows the history of the US dollar since 1973. This measure of the US dollar is an index calculated by the US Federal Reserve for the value of the dollar against a basket of seven major currencies. Again, three features of the series are visually striking.

Extrapolating both the most recent experience and the long term trend in the currency would suggest continuing weakness in the dollar exchange rate. However, the current position of the dollar, and its trading pattern since 2008, is also consistent with a flattening in its trajectory and, perhaps, in due course a trend reversal, too.

The currency has a link to corporate profits. The weaker dollar is helping to boost earnings, especially among the large number of S&P 500 companies now operating outside the USA. A currency reversal would throw into doubt the current earnings forecasts and the anticipated equity market upside implied by those expectations.

The direction of the dollar will also have a material impact on the prices of US dollar denominated commodities. A stronger dollar will sap their recent strength. A weaker dollar will reinforce the sustainability of strong commodity prices.

There is another reason for suggesting markets are on the verge of a tipping point. The US Federal Reserve's current program of quantitative easing is set to finish in June. Before then, members of the FOMC will have to address how they prepare the markets for a decision to stop or extend the program.

Even if the committee decides not to extend the securities purchasing program, it will have to address questions about the transition to a new policy setting. For example, how much of the interest income from existing security holdings and the proceeds of maturing securities will be used for fresh security purchases?

The point of these notes is not to offer a forecast for earnings, exchange rates or monetary policy. The point is to highlight how we appear to have reached a series of tipping points across a wide front.

Whether these measures of economic performance move up or down or remain unchanged in the next few weeks, we will not have long to wait to learn something about the future direction of a range of financial markets.

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This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.

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