More Of The Same Equals Less

Includes: DIA, SPY
by: Patrick J. O'Hare

Following the election, it has become clear that we have a problem. Actually, it is a math problem and it is this paradoxical equation: more of the same equals less.

Now, before we are accused of communicating a political bias in that equation, rest assured that is not our intention. The fact of the matter is that the equity market was doing just fine before the first presidential debate when polls showed President Obama would likely be re-elected and that Congress would remain split along the same majority party lines it is today.

Why, then, is the market in a tizzy after an election outcome that most thought months ago was the likely outcome? The easy answer is the one we highlighted in last week's Big Picture, "An Election Connection." There are new worries that bitter political feelings after the election will get in the way of achieving a compromise on the fiscal cliff.

That is a legitimate concern, but it is not the only thing worth noting right now.

A lot of the same moving parts are still influencing the market's behavior (i.e. fiscal cliff, eurozone, China, earnings slowdown). With, or without, a compromise on the fiscal cliff, the sum of those same parts will subtract from the growth outlook.

If the market isn't thinking that way, then it should.

The Sum of the Parts

Fiscal Cliff

Let's assume a compromise is reached that enables us to avoid the fiscal cliff. That will take a worst-case scenario off the table and lower the equity risk premium. The removal of a worst-case scenario should produce a boost for stocks in the short term.

What can't be forgotten in that compromise euphoria, though, is that any compromise will effectively mean less growth for the economy (already indicated by the CBO) since it will involve higher taxes, reduced spending, and most likely both. U.S. businesses say they will spend more if there is clarity on fiscal policy, but that view is a bit hollow because they don't know what the end result of a compromise will be. Moreover, if the compromise cuts into consumers' disposable income and weakens aggregate demand, as is likely, why would businesses rush to make new capital investments?

We have been warned by the CBO that a recession will occur if we go over the fiscal cliff. Even if there is a compromise, the cold reality is that we'll be stuck with more of the same subpar growth, which will be even less if businesses don't invest in labor and business capital as they say they will.

The market seems to be hoping for so much more economically on the other side of a compromise. All it is likely to get is more of the same subpar growth, and that will certainly equal less relative to expectations.


Let's turn to the eurozone now where so much more has been expected for years now. The regrettable fact of the matter is that things are getting worse, not better, in the eurozone despite numerous bailout efforts, unconventional central bank intervention, and efforts to restore fiscal order to government budgets. This has been plain to see on a number of levels.

Youth unemployment in Spain and Greece is north of 50%, several economies are in recession, violent protests have raged in the streets of Athens, radical political parties are winning more votes than they would otherwise, and now even the vaunted German economy is coming under pressure.

Fiscal austerity is destined to continue, however, which will raise the prospect of further social discord and economic hardship.

Those policies are necessary, but more of the same is going to equal less for companies doing business in the eurozone. McDonald's (NYSE:MCD), which gets 40% of its sales from Europe, provided us with a reminder of that when it recently reported its first, global comparable store sales decline since 2003.


China is on the cusp of a major leadership change that occurs once a decade. Even so, one thing is certain to remain unchanged: the Communist Party will continue to control China. Hu Jintao and Wen Jiabao will soon cede their leadership roles as president and premier, respectively, to Xi Jinping and Li Keqiang.

Jinping and Keqiang will enter office at an increasingly challenging time for the Chinese economy, which has been buffeted by the slowdown in the eurozone, inflation pressures, trade tensions, political corruption, and worries about a real estate bubble.

While there is a large measure of uncertainty regarding the views of the new leaders, it seems certain that they will look to continue China's emergence as a leading economic power while helping to forge a path to stronger growth that prevents social unrest.

The leadership names will be different, but we are expecting the new leaders to embrace the same policies that have facilitated the impactful influence China now has on the world economy.

With growth slowing abroad, China will remain inclined to endorse self-serving policies that keep trade and geopolitical tensions high. Accordingly, that will act as an impediment to growth as it lessens the earnings potential of companies competing with Chinese businesses and competing for Chinese business.


The last time earnings declined was in the third quarter of 2009. That growth streak may soon come to an end.

According to FactSet, third quarter blended earnings are projected to decline 0.1%. Third quarter revenue, meanwhile, is projected to drop 1.2%. If the energy sector is excluded, revenue would be up just 2.0%.

The weak revenue growth is a reflection of weak aggregate demand.

With the fiscal cliff headwind, the austerity measures in Europe, and China's slowdown, it is difficult to envision revenue growth accelerating much, if at all, from current levels. That will put the onus on companies to keep growing earnings by expanding profit margins that are already near record levels.

Many companies showed an ability to do that in the third quarter, but with demand slippage, that task will get increasingly difficult without cutting payrolls. Increased layoffs will spur an adverse feedback loop for the economy.

More of the same weak demand then will either equal fewer profits or fewer workers on payrolls. Not good. In the meantime, we know the earnings outlook is deteriorating.

The negative-to-positive pre-announcement ratio for the fourth quarter is 3.8. That is the highest since the third quarter of 2001 and it has prompted a downward revision in the fourth quarter growth estimate to 5.6% from 9.3% at the end of September and a reduction in the first quarter growth estimate to 3.4% from 5.3%.

What It All Means

The stock market may be stuck on the fiscal cliff issue, but the real issue is that the stock market is on course to be stuck with more of the same. The eurozone is still a mess; China is going to be self-serving; revenue growth and earnings growth will be lackluster; and the fiscal cliff, no matter the outcome, will lead to economic growth that is below potential.

There is more to the market's recent decline than just the fiscal cliff worries. The status quo on several fronts can suitably be thought of as the status woe, because the more things have changed, the more they have stayed the same. And when so much more has come to be expected, it is fair to say more of the same equals less.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.