Monday, March 28, 2016

The GAAP gap as Rorschbach test

I've been meaning to write on this topic but I hadn't gotten around to it. For several weeks, I have seen warnings about deteriorating earnings quality. The gap between corporate earnings as defined by Generally Accepted Accounting Principles (GAAP) and operating earnings (earnings without the special bad stuff) has been widening to levels not seen since the last market crash.

Here is a chart from Zero Hedge which showed that the gap between GAAP and Non-GAAP earnings is at its worst since 2008.

The level of write-offs are absolutely horrendous.

On the other hand, this chart from Goldman Sachs is suggestive that these earnings "gaps" occur at the height of bear markets. If we are already through the worst of these writeoffs, could such a development be actually equity bullish?

Urban Carmel also pointed out that outside of recessions, the "GAAP gap" actually isn't that bad on a historical basis.

Interpreting the GAAP earnings quality gap is like the Rorschach inkblot test. Bullish or bearish? What`s the real story?

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