Just a growth scare or prelude to something bigger?
The S&P 500 is up over 200% from the March 2009 lows and this bull market currently trades just shy of 17x forward earnings and is 7 years into the cycle. However, we know bull markets don’t die of old age or from what are reasonable, yet higher, valuation levels. As the market was grinding through the end of Q1 2016, we’ve once again, knocked on the door of all-time highs in the S&P 500 after roaring more than 13% from the February lows. Just weeks ago, the market had been anxious about the potential of a looming recession, and although some of the economic data has firmed of late, along with the price of oil and the cooling off of an upward trend in the US dollar, the economy barely grew in the 1st quarter of 2016 (after seasonal adjustments).
So what does all of this mean? The firming and now rebound in oil prices helps, in part, to alleviate some of the big concern regarding failing companies in the energy space and consequently the impact on financial institutions and their related loan portfolios. More broadly for US corporations, a strong dollar has been an often-talked-about headwind in earnings for many consecutive quarters now. However, thanks to the Federal Reserve’s more accommodative stance and language regarding monetary policy, the dollar has weakened against other major currencies, such as the Japanese Yen, in which it’s down over 10% in 2016.
With the recent trends in oil, a weaker US dollar, a dovish Federal Reserve, on top of what appears to be a continued stabilization of Chinese growth, it doesn’t necessarily mean we’re smooth sailing ahead and in resumption mode of this lengthy bull market. However, these recent trends are encouraging and as we’ve conveyed for the last several quarters, a recession doesn’t appear to be in the cards just yet. For now, perhaps we can focus on just how good earnings are, or aren’t, in order to get a sense of the next leg in this market.
As we enter the second quarter, earnings per share on the S&P 500 are expected to drop by 9% (according to FactSet*), which will mark the 3rd consecutive earnings growth decline. However, due to the above mentioned oil strength and weakening dollar, we just might end up seeing an upward revision to already lowered S&P 500 earnings projections for 2016. To help put into context, at this time last year, projected earnings per share on the S&P 500 had been as high as $130. During the lows of the Jan/Feb sell-off that optimism had soured to earnings per share expectations for the S&P 500 to under $118. If Q1 earnings season goes relatively well and that expectation bumps up to the $123 range, we’re still looking at a market multiple at the higher end of its historical range, near 17x earnings. Historically, when corporate profit margins are steadily declining, as they have been for over a year now, and consecutive quarters of earnings growth occurs, it has often preceded or coincided with a recession, but this is not always the case.
With continued easy monetary policy from Central Banks across the globe, including our Federal Reserve here domestically, investors are hoping for a late cycle resumption of growth, perhaps driven by this period of low energy prices that can help spike consumption, which has been somewhat disappointing of late from what is more typically a spendthrift consumer. For now, it appears this recent market bounce back is a recalibration to the higher end of a price to earnings (PE) multiple range relative to history, given continued tame but rising inflation, a low interest rate backdrop, and the recent evidence to suggest a “growth scare” is more likely than an outright recession for the US at the moment. However, investors need to be very cognizant of risks and return and put themselves in the emotional mindset they’re in during extreme selloffs and highly volatile periods in effort to determine whether current asset allocation is appropriate.
*“Earnings Insite.” FactSet Research Systems Inc. 15 April 2016.