Most analysts agree that the US recovery is well under way, but Societe Generale analyst and world-famous bear Albert Edwards thinks that investors should be concerned about falling MSCI profits, because they signal a much weaker recovery than pro forma IBES profits which could be undone by problems in Asia.
“We have long believed that economists should monitor the profits cycle as closely as equity strategists,” writes Edwards in a March 25 report. “Over the years we have found that profits are probably the single most important leading indicator of recession. A decline in profits is inevitably followed by recession shortly thereafter as investment, the most volatile of all GDP components, is cut.”
Edwards isn’t interested in IBES profits
To be clear, Edwards isn’t talking about the level of profits, the rate of profitability, or even profit margins. He is specifically interested in profit’s rate of growth, and he has found MSCI trailing reported profits to be more reliable than earnings estimates (he quotes GMO analyst James Montier as calling IBES profits “undefined, unregulated, and untrue”), so the growing gap between the two has him worried.
MSCI trailing reported profits growth is a leading indicator for business investment, and right now it forecasts a drop. While business investment is only 13% of GDP, if you include business inventories it is one of the biggest sources of volatility in GDP growth from year to year.
NIA data released later this week
The conclusion is that falling MSCI profits foretells weak business investment, which normally goes hand in hand with weak GDP growth, but that’s not the whole story. Edward’s favorite source of profits data isn’t yet available, and the latest information we have is positive.
“Our preferred measure of NIA whole economy profits seems to be still advancing in the midsingle range and is not currently flashing an imminent recessionary warning. But the data only go up to Q3 last year,” he writes.
NIA (national income accounts) whole economy profits data includes non-quoted companies, so it gives a fuller picture of what’s happening in the economy, and even leads stockmarket profits. At the end of 3Q2013 NIA profits were starting to inflect up, and if that trend continues then Edward’s own analysis seems to suggest that we can expect a reasonable GDP growth rate this year, but he doesn’t seem hopeful. Either way, we’ll find out when the US Bureau of Economic Analysis releases NIA data this Thursday.