Hillary Clinton may become the first female president of the United States, but she’ll never be as powerful as Janet Yellen. The head of the Federal Reserve announced that interest rates would stay put, noting that economic activity has slowed and, as a result, consumer spending has declined. Despite the moribund outlook on the U.S. economy and abysmal first-quarter gross domestic product (GDP) growth of 0.5%, the over-bloated S&P 500 clings to artificially low interest rates to save itself from itself.
Psychic Federal Reserve Eerily Well-Informed?
The Federal Reserve didn’t really surprise anyone, or at least I hope no one was taken off-guard, when it announced it was holding its key lending rate in the range of 0.25% to 0.50%. (Source: “Federal Reserve Statement,” Board of Governors of the Federal Reserve System, April 27, 2016.)
Back in December, the Federal Reserve announced its first rate increase in almost a decade, saying future rate hikes in 2016 would be gradual. Most presumed this would mean four moderate rate hikes. But that presumption is in jeopardy now, as the U.S. economy remains fragile. Fears that weak global growth and a frenetic stock market could further damage the U.S. economy means we are not out of the woods just yet—far from it.
For investors, that means more cheap money. Not surprisingly, markets responded in kind, climbing higher following the announcement.
Still, most think the Fed will raise rates in June. But frankly, if the statistics-hungry Fed pays attention to its own data, I think a June rate hike is off the table. Yes, Yellen noted that the global financial markets are improving and downplayed recent weakness in the U.S. economy, but I think that dovish optimism may be a little premature.
Weakest GDP Growth in Two Years
In the Federal Open Market Committee (FOMC) statement, Yellen observed that U.S. economic activity had slowed and reduced levels of consumer spending. That’s not good news for an economy that gets the vast majority of its GDP from consumer spending.
Still, the eerily uninformed analysts on Wall Street continue to wax eloquence about the strengths of the U.S. economy. One wonders why when U.S. GDP has been declining for the last four quarters and most recently, we learned that the U.S. economy lurched ahead at a 0.5% pace in the first quarter as consumers put the brakes on spending and businesses cut back on investments. (Source: “Gross Domestic Product: First Quarter 2016 (Advance Estimate),” Bureau of Economic Analysis, April 28, 2016.)
Expecting first-quarter GDP to advance a princely 0.7%, analysts seem surprised that the economy remains weak. After all, the global economy doesn’t seem all that bad, employers are hiring, and the stock market has recovered from the mid-February lows.
That’s all a little rich.
China’s first-quarter GDP growth decreased to its slowest pace since the first quarter of 2009, expanding 6.7%. China’s economy expanded at a seasonally adjusted rate of 1.1% in the first quarter from the fourth quarter of 2015. That’s the lowest quarterly expansion since 2010. China, the world’s second-biggest economy, reported 2015 GDP growth of 6.9%, its weakest growth rate in a quarter-century. (Source: “China first quarter GDP growth slowest since 2009,” International Business Times, April 15, 2016.)
As for U.S. jobs, employment did rebound in March, adding 215,000 jobs. Most of the employment gains (48,000) came from low-paying retail and food services (25,000), while job losses came from the higher-paying manufacturing (-29,000) and mining (-12,000) areas. The official unemployment rate is five percent, but the underemployment rate has only fallen by about one percent since last March and stands at 9.9%. (Source: “Employment Situation Summary,” Bureau of Labor Statistics, April 1, 2016.)
Stocks Rise Along Despite Declining Earnings
The stock market has made a remarkable recovery from its February lows. But those gains aren’t a result of stunning first-quarter earnings and revenue growth.
The markets are rebounding because investors are ignoring the earnings recession we are in and, being impatient, are hanging their investing cap on artificially low interest rates and the well-intentioned notion that the U.S. economy is going to rebound—soon. They’re going to have to wait a while longer.
The U.S. is in an earnings recession. It’s difficult to see how weak earnings point to higher stock valuations and are a reflection of an improving U.S. economy.
I enter as evidence, on December 31, 2015, the estimated earnings growth rate for the first quarter of 2016, which was 0.3%. Fast-forward to March 18 and the estimated earnings decline was -8.4%. At the end of the quarter, the estimated earnings decline for the first quarter increased to -8.7%. (Source: “Earnings Insight,” FactSet, April 15, 2016.)
Welcome first-quarter earnings season. By April 15, the first-quarter blended earnings decline was -9.3%. By April 22, with 26% of companies in the S&P 500 reporting first- quarter earnings, the blended earnings decline improved to just -8.9%. (Source: “Earnings Insight,” FactSet, April 22, 2016.)
Keep in mind that 74% of S&P 500 companies need to report first-quarter earnings. That number will invariably change. Any improvements to blended earnings will be marginal at best.
If the S&P 500 reports a decline in earnings for the first quarter, it will mark the first time the index has seen four consecutive quarters of year-over-year declines in earnings since the fourth quarter of 2008 through the third quarter of 2009.
At a time when corporate America is warning that earnings will be down significantly, stock valuations have been rising. Since the markets bottomed in the middle of February, the S&P 500 has soared more than 13%.
It doesn’t add up. But again, you can’t fight the Fed. Eventually, investors will have to come to terms with weak fundamentals and how they are justifiably supporting an aged bull market.