The View From the Executive Sweet?
by Brian Pretti CFA, Contrary Investor. December 19, 2008
To suggest the markets have been quite the volatile beasts these days is quite the understatement. Have equities already fully discounted the economic negativity that has both transpired so far and is yet still to come? As we move into 2009, this is indeed one of the key questions. Yes, we all know that equities bottom prior to recession conclusions. And if indeed the US remains in recession as of next April, ours will be the longest continuous recession since the depression. Hence, we have a lot of folks quite ready to jump the proverbial gun and get a good head start on the next bull market, which is sure to ultimately arrive. But, ahhh…the important question is when? And that will determine a true bear market bottom as opposed to a bear market rally bottom. Quite the differentiation, no?
Time for a very quick check in on the current sentiment from the executive suite, if you will. Just what have the CEO’s and CFO’s of this wonderful world been telling us lately. THE reason I’m bringing this up, as you’ll see in just a minute, is that in very recent surveys, CEO and CFO optimism has taken one very big step backward. Historically, it has paid to listen to these folks as their sense of economic, and really market, timing has been exceptional. Time to listen.
Every quarter I check in on the Conference Board CEO confidence survey due to the fact that this survey has been virtually impeccable in terms of helping us to time/corroborate the conclusion of official US recessions. You can forget the “information” from the NBER regarding the economy (we simply do not have the time to wait around for these folks to render an opinion) as the CEO crowd has been absolutely prescient in terms of their timing regarding key US macro economic cycle turning points as per their survey results over time. Based on historical experience, watching the CEO confidence survey will be one the key pieces of a broader puzzle of pretty darn near real time information (published quarterly) concerning the ongoing reality of the US economy.
It just so happens that yet another affinity group (ya just can’t have too many, can you?) for the wonderful corporate CEO’s in this country is the Business Roundtable. As per their own description, the Business Roundtable is “an association of chief executive officers of leading U.S. companies with $4.5 trillion in annual revenues and nearly 10 million employees. Member companies comprise nearly a third of the total value of the U.S. stock markets and represent over 40 percent of all corporate income taxes paid to the federal government”. It also just so happens that members of the Business Roundtable likewise conduct their own quarterly CEO Economic Outlook Survey. The survey index they put together reflects their forward six-month expectations for sales, cap-x and employment. The reason this is important now is clearly apparent as you look at the chart below.
The clear drawback in looking at the history of this survey is lack of longer-term history, if you will. But the issue of the moment is the near cliff like drop in the 4Q 2008 survey that hit the tape recently. Again, anyone even tangentially paying attention in this world knows the US economy has been under extreme stress and pressure for some time now. I’ve been advocating this viewpoint for quite some time and the NBER essentially validated this thinking by backdating the current recession to December of last year. The important issue of the moment is, why are the CEO’s just now getting around to voting quite negatively about the forward six-month prospects of the US economy? Have they not been paying attention? I sincerely doubt that’s the case.
Let’s very quickly review the exact data for the current period that went into making up the composite outlook index you see above. The following table does the trick and represents the exact component numbers from the survey:
|Business Roundtable Key Survey Questions|
|Component Question||Increase||No Change||Decrease|
|Expectation For Sales Over Next Six Months||38%||17%||45%|
|Expectation For Cap-X Over Next Six Months||10||39||52|
|Expectation For Employment Over Next Six Months||9||32||60|
Remember, these CEO’s are telling us what they believe will happen over the next six months. Not exactly a pretty picture, now is it? It paints a distinct picture of acceleration to the downside. Again, the CEO’s have been asleep at the wheel as the current economic cycle has deteriorated up to this point. We need to step back for a minute and try to think about just what the character of their current response is “telling us” (this survey was conducted between November 3rd and 17th). Although I plan to expand on this theme in our early year 2009 discussions, the current CEO responses are telling us that recent September to present events in the credit markets and financial markets will have a very big follow on “echo effect” in the real economy at least over the next six months. And that fallout effect into the real economy will not be positive, which is no new news by any means. The financial markets are fully aware.
As I have been hammering home ad nauseum, it's a matter of magnitude and duration that is most important to our investment decision making directly ahead. As to the suggestion above in terms of many a headline Street market seer now suggesting equities should be bottoming in anticipation of a recession conclusion based on historical time period experience, the current Business Roundtable survey standing in a good bit of juxtaposition appears to be telling us that the worst period for current real world domestic recession character and economic outcomes lies dead ahead, not behind us. It’s just something to keep in mind as we struggle with the day-to-day tension of assessing what the financial markets have already discounted and what may be left to discount in the current cycle. We all know that this discounting process will be rhythmic in nature. Who knows, maybe the CEO’s are being most pessimistic right at what in ultimate hindsight might come to be seen as the conclusion of the present recession over the next six months. Either that, or investors are jumping the gun in trying to discount a near term recession conclusion in current equity prices by calling for a current bottom. Decision-making under uncertainty, who ever said this was easy? But it's this very process and path of reasoning that can indeed create bear market rallies of significance. Bottom line being? Sure, we may easily get a meaningful and perhaps even multi-month equity rally, but the facts of the CEO survey as just one anecdotal piece of information are telling us to proceed with a bit of fundamental caution about discounting an actual conclusion to macro economic difficulties over the next six months. As always, momentum and fundamentals can run at alternate paces. We just want to make sure we're betting on the winning long-term factual horse regardless of near term financial market movement. Bottom line, this survey stands in a good bit of perceptual juxtaposition. At exactly the time a number of former headline financial market bears are getting less bearish about equities, joined of course by Street strategists everywhere, CEO's are actually getting more bearish about real world outcomes that lay before us. And bearish to a degree of collapse not seen before in the short history of this survey. It appears that either the CEO's are dead wrong and far too negative, or the equity bottom callers of the moment may be called back to the starting line at some point for a false start.
Two last tidbits from the Roundtable survey. For the first time in the history of the survey, CEO’s cited pension costs as a major concern. With equities and many a non-Treasury bond collapsing in price over the last six months, you bet it’s a concern. Underfunded pensions will be a drag on corporate earnings and State and local municipal budgets for some time to come if the financial markets remain difficult. Lastly, 56% of the CEO’s tell us their borrowing costs have increased as a result of recent credit market events. Again, no major revelations for anyone who has not been asleep.
The Low Down
Luckily in addition to the Business Roundtable results covered above, the Duke/CFO survey hit the tape last week. As with the Roundtable survey results and history, the CFO optimism survey likewise shows us very meaningful current period deterioration. I place a good deal of significance on the CFO and CEO surveys as being important anecdotal economic indicators based upon past track record of these two branches of the executive suite. The chart below is the history of the net percentage of CFO’s optimistic about the forward character of the economy (optimistic less pessimistic). The results speak for themselves – the lowest reading in what is the short history of this survey.
But maybe THE most important piece of data from the recent survey is a response series regarding earnings expectations. Unfortunately the history of this question to the CFO’s is limited, but again it’s the level and direction of current period response that is quite the important message and marker of change. We’re looking at CFO responses to the question of earnings growth expectations over the forward twelve-month period. Be aware that this data covers only public company CFO responses and the CFO’s are answering this question specific to circumstances at their own firms, not corporate earnings growth in aggregate.
The juxtaposition of current responses relative to recent historical experience simply speaks for itself. Like headline CFO optimism and the recent CEO outlook, current responses are a directional cliff dive. On our subscriber site I recently reviewed headline S&P earnings expectations for 2009. Without sounding egotistical, current estimates of new all time highs for 2009 S&P earnings are absurd. In the current survey, the CFO’s are simply reinforcing this notion of earnings growth expectations absurdity. I take this very seriously. Although the financial markets have clearly gone a long way toward discounting poor earnings to come given equity and fixed income price declines of this year, the reality of actual disappointments lies dead ahead. Again, the concept of magnitude and duration of slowing applies to corporate earnings as well as the economic cycle as a whole. Magnitude and duration of weakness are the key issues we need to assess, monitor and anticipate potential change. It’s clear in the history of this survey response point that up until now the CFO crowd has certainly been concerned about forward earnings growth given the directional deterioration in their earnings outlooks. The current response simply takes “concern” to a whole new definitional level, right? Don’t forget what these folks are telling us. The messages of the CFO and CEO surveys are coincident.
A few final anecdotal survey tidbits. The top three macro concerns of the CFO crowd at present are consumer demand, credit markets/interest rates, and housing market fallout. Fifty-eight percent of the respondents do not expect US economic recovery until 4Q 2009 or later. We’ll just have to see how they feel as we move further into 2009. Fifty-eight percent of respondents tell us the credit crunch is hurting the economy. Not exactly a wild revelation. On a bit of an ancillary note, 45% of Chinese CFO's say they have experienced a slowdown in exports. Only 8% of the Chinese CFO's expect Chinese government stimulus to substantially jump-start the Chinese economy. Seventy-three percent believe it will simply provide some cushion (but not acceleration). So there you have it. Again, the keynote feature of both the CFO survey and CEO outlook is the unprecedented deterioration in their forward twelve-month outlooks at the current time. And what highlights this change is that since the first quarter of 2008, survey responses of CFO’s and CEO’s have been getting less negative/incrementally more positive with each passing quarter…until now. That was turned on its head in the recent survey period. As I have been suggesting in recent discussions, we need to be very aware of the potential echo effect into the real economy of both credit market and financial market events of the September to present period. Are the CFO’s and CEO’s telling us this rather dark echo effect is upon right now? It sure seems that way.
Let’s see who is right and who will be wrong. Either the markets are correct and the bottoming process we have been living through and with since November is telling us better days for the economy lie ahead, or the markets are jumping the gun as the degree of recent bearish acceleration in both CEO and CFO outlooks is telling us real world conditions are about to take a turn for the worst (like they have not been turning down already). Have the markets already priced in further economic deterioration from already relatively bleak current levels? Stay tuned as the answers lie probably in the first quarter of 2009. For now, the view from the executive suite is not so sweet at all.
© 2008 Brian Pretti