EC 4 Warnings And Why You Should Pay Attention

When I was growing up my father, probably much like yours, had pearls of wisdom that he would drop along the way. It wasn’t until much later in life that I learned that such knowledge did not come from books, but through experience. One of my favorite pieces of “wisdom” was:

“Exactly how many warnings do need before you figure out that something bad is about to happen?”

Of course, back then, he was mostly referring to warnings he issued to me “not” to do something I was determined to do such as jumping off the roof with a bedsheet convinced it was a parachute. After I had broken my wrist, I understood what he meant.

Over the weekend, those warnings came to mind as the recent bounce in the financial markets once again has individuals scrambling to grab “bedsheets” to jump off the roof once again. Of course, much of their behavior is driven by mainstream commentary suggesting that the recent market rout is over. 

However, there are currently plenty of warning signs that suggest that individuals might want to reconsider the risks before taking that leap. Here are four warnings to consider.

Warning 1: Profit Margins

Edward Harrison at Credit Writedowns picked up on the issue of declining profit margins that I addressed last week. 

While I am not talking about recession yet, I do think we are seeing economic weakness toward the end of the business cycle. And while that doesn’t mean recession in the near-term, it could do in the medium-term.

We know from history that the dates when profits rolled over coincide very much with the slide into recession. My interpretation of these data is exactly as Barclays says, that you get enough of a slide in profits and it generally leads to recession. That is because the profits recession comes as a result of a weakening economy that has weakened so much that companies are no longer able to cut costs, buy back shares or massage accounting enough to keep profits rising.

Profit-margin-barclays

We are now in the seventh year of a cyclical recovery and bull market. Shares have tripled in that time frame. I would say this means we are much closer to the end of the business cycle than the beginning. Moreover, as Jeremy Grantham is quoted in the Business Insider piece, profits are mean-reverting and right now they are reverting from a phase that is “wildly optimistic” according to Warren Buffett. All of this is taking place against the backdrop of an economy in which wage growth is weak, household debt is still relatively high on a historic basis as a percentage of income and we have no policy room on the monetary side, with limited political appetite for policy on the fiscal side.

To me, the pre-conditions for this profits recession speak to downside risk, both for risk assets and for the real economy. None of the data speaks to recession in the real economy right now. We are seeing a slowing of job growth and likely of trend economic growth as well. But with a profits recession hitting, the potential for further downside is high.”

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Author: Travis Esquivel

Travis Esquivel is an engineer, passionate soccer player and full-time dad. He enjoys writing about innovation and technology from time to time.

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