You may have seen that the quarterly Duke/Fuqua CFO survey was released last week. Always worthy of a quick check in based on the very simple truism that “the CFO always knows”. Who better to have a read on the true pulse of business fundamentals? In hindsight CFO optimism responses have foreshadowed directional movement in both the year over year rate of change in real US GDP and the S&P 500, especially over the current cycle. The good news is that CFO optimism in 1Q 2012 rose nicely over the prior quarter, and very meaningfully over where these numbers stood in the third quarter of last year. Feeling better about life as of late? Indeed.
But the breadth of responses beyond just the headline in the current survey deserves a bit more consideration as these various response points may be telling us something about the changing perceptual influence of monetary policy (money printing) in the current cycle as seen through the eyes of the CFO crowd. After all, CFOs are people too, right? They are human beings susceptible to the same perceptual influences as the broader investment community. Again, the CFOs have been out in front of subsequent period directional change in the real economy and equity markets as per the history of this survey. Will it be so again in terms of the potential for changing perceptions regarding the benefits, or otherwise, of central bank money printing?
The top clip of the chart below is the history of CFO levels of optimism each quarter. Overlaid is the year over year change in real US GDP. As is clear, I’ve marked the quarters in which central bank balance sheet expansion has begun over the course of the current cycle. In every single quarter after monetary expansion has begun, CFO optimism has risen in more than noticeable fashion. We’re seeing exactly the same thing in the current quarter, so this rhythm and perceptual response by the CFOs to money printing has been very consistent.
The bottom clip of the chart above reinforces this message of positive response to monetary expansion, this time looking at net CFO optimism (percentage of those optimistic less the percentage of those pessimistic). You can see clearly the direction of net responses has led the year over year directional change in equities as measured by the S&P (price only). CFOs have been optimistic during periods of money printing and so has the investment community.
But as mentioned, if we drill down just a bit into the component responses within the survey, a pattern of perceptual change appears to be emerging in the world according to the CFOs. Below is a chart of CFO responses detailing what they expect over the next 12 months in terms of inflation (the change in the price of their own products) as well as, and very importantly, their own company earnings growth rate. As you can see, when QE I was first initiated, inflationary expectations were very subdued and remained so over the course of 2009, ultimately accelerating in early 2010. Message being, at least at that time CFOs were not concerned about the inflationary potential created by central bank money printing. But that perception certainly changed with the advent of QE II. Once again we also see an immediate uptick response to expected inflationary pressures by the CFOs with the current round of LTRO/Fed $ Swap. Have the CFOs learned to equate central bank money printing with rising inflationary pressures? That absolutely appears to be the direct message over the past few years. Pretty much an immediate response at this point.
In the bottom clip of the chart we’re looking at CFO forward 12 month earnings growth expectations. With the advent of QE I, CFO earnings expectations reversed strongly right at the outset of initial monetary expansion. QE was certainly quite the positive perceptual force. We saw exactly the same response when QE II was initiated, but with the second iteration of monetary expansion, the perceptual “feel good” for CFOs in terms of their forward earnings trajectory was very short lived. One quarter of increased earnings expectations before again turning a bit dark. Now that LTRO and the Fed dollar swap have been initiated, with Fed hints of sterilized QE III dancing in investors heads, it seems the CFOs aren’t buying it in the current quarter. Yes, we know margin pressures are growing and productivity is no longer a tailwind, but in the current quarter the CFOs have lowered their forward earnings growth expectations slightly from the prior quarter, despite the magnitude of current global money printing which outstrips anything we have seen to this point. With the current round of monetary expansion, CFOs apparently see higher inflationary pressures with no real benefit to earnings growth. This is a complete change from the rhythm we have seen in the cycle so far.
As I’ve said for years, the real corporate confidence measure is that of capital spending. As we look at current CFO responses to their expectation of forward 12 month capital spending, we again see what sure appears to be perceptual change regarding the supposed real economic benefits of central bank money printing. With Fed QE in both 2009 and 2010, CFOs immediately raised their outlook for capital spending in subsequent quarters. QE arrested prior period perceptual declines instantly. But not this time as CFOs actually ratcheted their growth assumptions for capex down. As you know, a big piece of the consensus bullish economy thesis, especially for the US, rests on exports and capex (manufacturing). One more time, CFO perceptual response to the current round of really global central bank largesse is muted, completely unlike the prior two iterations.
So despite a very positive macro headline optimism response by the CFOs in the current quarter, when we drill down into the various components of the survey we seem to be getting another message. A message that tells us unlike the first two QE experiments, CFOs no longer equate QE with rising earnings growth. They seem to be equating it with rising inflationary expectations and their response is to lower the growth rate of forward capital spending.
I’ll leave you with one final anecdotal chart. Below we’re looking at CFO forward expectations of dividend and stock buyback increases. In other words, the use of corporate cash. Expectations for dividend growth fell meaningfully last quarter and in like manner CFO expectations for stock buybacks experienced their greatest one month jump in the short history of the survey. At the time I considered it a natural in light of the changes to come in dividend taxation as 2012 concludes. But you can see that in the current quarter, CFO expectations for both dividend increases and stock buybacks have fallen. The drop in expected buybacks essentially plummeted. Is this “telling us” CFOs see a need to conserve cash? Is the drop in expected buybacks telling us CFOs see equity prices as unattractive, perhaps matching the rise we’ve seen in insider sales over the last few months?
Of course the answer to all of these questions lies ahead. I just thought it important to point out the change we are now seeing from the very folks who I consider to have the greatest insight into the reality of corporate fundamentals, often well ahead of the Street. The CFOs seem to be telling us QE is no longer the perceptual positive it has been since 2009. Investors certainly have not yet adopted this perception (by a long shot) as they seem to hang on every central banker comment. Historically it has paid to heed the message of the CFOs. Will it be so again? We’re going to find out dead ahead.
