The CFO Nose
by Brian Pretti CFA, Contrary Investor. March 27, 2009
Can you believe it? Another quarter has slipped by and it’s once again time to have a very quick check-in on what the CFO’s of major US companies have to say about life as they currently see it. The CFO survey hit the tape a few weeks back. We’ve been through this many a time so we’ll stick to the highlights. THE reason we check in regularly with this survey is that the CFO’s have been quite the fortunetellers regarding macro economic conditions, at least during the period of the current decade that this survey has been published. The bottom line in the current survey is that the CFO’s remain quite the pessimistic group at the moment. As CFO Magazine tells us in the survey, “This is very troubling. Throughout the history of our survey, CFO’s have shown a remarkable ability to predict future economic conditions. They anticipated the current recession as far back as September of 2007. Given the CFO’s track record, the historic pessimism CFO’s are currently expressing certainly indicates a tough road ahead in 2009.” Let’s get to the highlights of the report and we’ll let the facts speak for themselves.
As you might remember, each survey delineates separate levels of CFO optimism and pessimism. We dissect the numbers in a variety of ways. Below is a look at CFO optimism levels only set against the quarter over quarter change in real US GDP expressed in dollars. First, although not at record lows, current levels of CFO optimism are darn close enough to those lows. After a very brief brush with increasing optimism last quarter, the CFO’s have again retreated to their caves of dark emotion.
The reason we like to look at the changing rhythm of optimism separately is that at least since the last recession, rising levels of CFO optimism in isolation have indeed correctly foreshadowed forward or like period increases in quarter over quarter real GDP. It’s no wonder CFO Mag believes in the prescience of their precious CFO’s, no? Very much in like manner, when levels of CFO optimism begin to decline, it’s a good bet prior period quarterly GDP strength is about to diminish. This is the history of the chart above. The recent survey is a draw, so to speak, as levels of optimism are up a whopping 2% from the prior quarter, which was a very low base to begin with. Hardly noticeable in terms of improvement. They remain dark in outlook in absolute terms.
Another view of life we prefer in terms of looking at the numbers in the report is to look at “net” CFO optimism. Simply put, it’s the percentage of those CFO’s who are more optimistic less the percentage of those more pessimistic to come to the net number. And that’s exactly what you see below. In essence, we are netting out the CFO’s whose opinions are unchanged. In this chart we’ve included the quarter end price of the S&P. Have a look.
A few comments. First, you can see as you look back to 2003 what a recovery in CFO net optimism really looks like. It’s definitive, it’s big and it’s unmistakably bullish. We're looking at something quite the opposite in character at present. Secondly, although the data is very short in terms of history, it seems that once CFO net optimism drops below –40%, it’s pretty much look out below for the equity market. In fact the first quarter where we saw CFO net optimism do exactly this, drop below –40%, was the third quarter of 2007 where the S&P concurrently peaked above 1500 and then never saw this level again on a quarter end basis. For now, net CFO optimism remains deep in negative territory. Not a good thing in terms of their expectations for the forward character of the US economy and apparently not a good thing for equities.
Finally, although this is just an eyeballing the chart comment, it seems keeping tabs on the quarter end S&P 500 by itself may indeed be a worthwhile exercise in terms of corroborating and helping to characterize the macro trend direction of the S&P specifically and as being representative of the equity market as a whole. From the low in 2002, it never again reached a new low on a quarterly basis, with the higher low in 2003 a divergence that told us (of course in the clarity of hindsight) a new bull had been borne. There were indeed a few quarter end downturns in S&P price on the way to 1500 and beyond, but by and large the quarter end directional rhythm did a great job of keeping investors on the right side of the macro trend. And from the top above 1500, it has been no miss on a quarter end basis all the way down in terms of consistency of directional trend. Not one up tick. Will this quarter end view of life be helpful ahead? We plan to throw it in the toolbox and see where we go from here. We’ll let you know.
Final chart from the standpoint of current CFO perspective as we approach 1Q 2008 earnings reporting season, and it’s not a fun chart at all. We initially showed you this one last quarter as it broke into negative territory for the first time in the very short history of this data point. We’re looking at forward twelve-month earnings expectations from the CFO’s office. And let’s face it, as we’ve said in the past, of all the folks in the executive suite, the CFO knows. Any questions regarding the direction of where the CFO's see earnings traveling ahead?
We’ll wrap up and move on with some final key summation results from the report. First, only 35% of the CFO’s surveyed expect an economic recovery to begin this year. The average of responses was that an economic recovery would not start for another 14 months. If that’s true and we believe the equity market bottoms four to six months in front of the economy, we should not be looking for an equity market bottom until the end of the year at best. Only 32% of the CFO’s believe the economy will be better off due to the Federal Stimulus plan. Have they told Wall Street yet? Apparently not. 53% say their companies will be worse off if health care were nationalized.
Very importantly, on the employment front, we suggest the news could not be worse. In aggregate, CFO’s expect to layoff 6% of their workforce this year. If they are even near correct with this comment, this translates to 7.6 million additional jobs to be lost. If that’s the case, we are not even half way through the current payroll contraction cycle. Although these are our comments, the impact on consumption of layoffs of this magnitude? You don’t want to know. 60% of companies will impose a hiring freeze in the next twelve months. 57% of the CFO’s say they plan to reduce or freeze wages. 39% of CFO’s say they plan to reduce hours worked for retained employees. Now you know why we have been screaming so loudly about the decline in wage growth that is sure to come directly ahead. No question about it. Their comments are not good news for the domestic labor market.
Finally, the following table lists the top concerns of CFO’s right now, both macro economic concerns and concerns specific to their own companies. In many cases we’re seeing concerns that have never appeared before, but fit the current environment as we see it like a glove.
|CFO SURVEY - Top CFO Concerns|
|Macro Concerns For US Business||Concerns Internal To Own Firm|
|Consumer Demand||Ability To Forecast Results|
|Credit Markets/Interest Rates||Working Capital Management|
|New Administration and Congress||Maintaining Morale/Productivity During Economic Downturn|
|Housing Market Fallout||Balance Sheet Weakness|
There you have it. Another quarterly CFO survey under the belt. The bottom line is a pessimistic macro outlook. Is that new news as far as the financial markets are concerned? Probably not. If anything, their comments about the potential severity of labor market contraction still yet to come is something the consensus may not be expecting. As we have said throughout this year, if there is to be a surprise, it will be that general consumption will be much weaker than expected. CFO comments about how they see layoffs unfolding this year supports our thoughts on the severity of consumption weakness both currently evident and still to come.
As a final comment, and you know this, CFO comments reflect the real world and the real economy as they see it. Does that necessarily translate into further death and destruction in the equity markets? Now that the Fed/Treasury/Administration are committed to printing, borrowing and spending literally trillions, and if that’s not good enough then trillions more, that money is going to need to express itself or find an outlet somewhere in the real or financial economy. The CFO’s are telling us it’s a good bet they will not be borrowing and spending heavily. Recent capital spending numbers bear this out in spades. We watched Greenspan flood the system with money in the late 1990’s pre-Y2K and the NASDAQ summarily doubled. Current Fed/Treasury/Administration actions make Greenspan’s pre-Y2K liquidity party look like a picnic. Be careful out there. When money of this magnitude is being conjured up, we need to be open to a wide number of possible outcomes that may not reflect or mirror the immediate reality of the economy as the CFO’s of this world see it.
© 2009 Brian Pretti