With each passing day, there is more evidence that suggests the stock market is a dangerous place to be; the upside seems very limited and the downside risks are increasing.
At the end of the day, for key stock indices to go higher, revenues and corporate earnings of the companies that make up those stock indices must improve. Right now, this isn’t happening.
So far, 494 of the S&P 500 companies have reported their corporate earnings for the first quarter of 2015. The average earnings growth rate was just 0.7%; the lowest corporate earnings growth rate since the third quarter of 2012. (Source: FactSet, May 29, 2015.) Comparatively, the earnings growth rate for the first quarter of 2014 was 2.1%. (Source: FactSet, May 23, 2015.)
Now, here’s the real problem: Revenue in the first quarter of 2015 for the S&P 500 companies declined 2.9%. (Yes, I said declined.) When corporate America is experiencing revenue contraction, it’s a huge problem. Sure, companies can mask weak earnings growth with stock buybacks, but they can’t fake revenue.
Buybacks Make a Comeback
But these days, you shouldn’t believe everything that’s “reported.” The S&P 500 companies posted earnings growth of 0.7% in the first quarter of 2015, but know that these figures are “financially engineered.”
I have talked about this phenomenon before; companies on key stock indices are buying back their shares, thus making per-share earnings look better than they are.
Just look at one example of how it works.
On June 3, The Wendy’s Company (NASDAQ/WEN) announced a $1.4-billion share repurchase program. According to the announcement, “The Company expects high single-digit adjusted earnings per share growth in 2016 and adjusted earnings per share growth in the high teens in 2017. Due primarily to the expected benefit of the Company’s share repurchase plans announced today…” (Source: The Wendy’s Company, June 3, 2015.)
In other words, the company is admitting to what the share repurchase will do for it: i.e. increase its earnings per share.
How much is $1.4 billion relative to Wendy’s financial conditions? In the first quarter of 2015, the company reported revenues of $466 million. A simple math calculation will tell you that Wendy’s is spending three times its quarterly revenue on share buybacks (Source: The Wendy’s Company, May 6, 2015.)
Take out the share buyback programs and I doubt the S&P500 companies had any earnings growth in the first quarter of 2015. Like their revenue, I wouldn’t be surprised that, minus share buybacks, there was an actual contraction in first-quarter S&P500 earnings.
Where’s the Market Headed Next?
Stocks have gone nowhere this year as the Dow Jones Industrial Average chart below shows.
Chart Courtesy of www.StockCharts.com
Technical analysis of the above chart shows that a narrow trading range with a breakout to the bottom is more likely than a breakout to the top. Seeing this combined with weak fundamentals (stocks are overvalued when measured by so many different historically proven stock market valuation tools), I suggest extreme caution and capital preservation for investors.