Despite a year or more of not so subtle economic warnings, Wall Street and corporate American CEOs have been reassuring us that the U.S. economy is strong. But anyone who reads Profit Confidential knows that the U.S. economy has been charging toward a recession for a long time now. Somehow, the idea of a U.S. recession and a looming bear market has caught Wall Street off guard. I’m not sure how though. If I could see it, one has to ask why they couldn’t.
CEOs Finally Fear a Recession
U.S. stocks are off to one of their worst starts ever. The S&P 500 has lost 7.5% of its value so far this year, the Dow Jones Industrial Average is down almost seven percent, the NYSE is trailing six percent, and the tech-heavy NASDAQ has fallen 6.7%.
Not surprisingly, fourth-quarter results have been less than stellar. In fact, the blended (actual results for companies that have reported and estimated results for companies yet to report) earnings decline for the fourth quarter of 2015 is now -5.8%. (Source: “Factset Earnings Insight,” FactSet, January 29, 2016.)
If this is the final earnings decline for the quarter, it will mark the first time the index has experienced three consecutive quarters of year-over-year declines in earnings since the first quarter of 2009 through the third quarter of 2009. It will also mark the largest year-over-year decline in earnings since the third quarter of 2009 (-15.5%).
The blended revenue decline for the fourth quarter of 2015 is now -3.5%. If this is the final revenue decline for the fourth quarter, it will be the first time the index has seen four consecutive quarters of year-over-year revenue declines since the fourth quarter of 2008 through the third quarter of 2009.
American CEOs are not waxing eloquence about the health of the U.S. economy any more. In fact, those who pay attention to what CEOs say regarding the impact lower oil and gas prices, the strong U.S. dollar, and weak economic global economic growth are having on earnings and revenues—they cannot be happy.
That’s because more and more U.S. companies are concerned about a recession in the coming months—the first one since the end of the financial crisis. The number of companies whose executives have mentioned the recession is up 33% from the same period in 2014, marking the first increase since 2009. So far, 92 companies have mentioned a U.S. recession in their earnings calls. (Source: “U.S. CEOs unleash recession fears in earnings calls,” Yahoo! Finance, February 2, 2016.)
Fears of a U.S. recession do not bode well for earnings. At this point, 39 companies on the S&P 500 have issued guidance for the first quarter of 2016. Of these, 33 (86%) have issued negative earnings-per-share (EPS) guidance. This is well above the five-year average of 72%.
Fear not! Analysts predict significant increases in earnings and revenue growth in the second half of the year. But these are the same people who were surprised the markets have been tanking. So, I’m not so sure they have their finger on the pulse of the U.S. and global economies.
U.S. Economic Growth Anemic at Best
Why are fears of a recession finally coming to light? Because the world’s biggest economy simply isn’t doing that well. Fourth-quarter GDP crawled at just 0.7%. Far less than the two percent in the third quarter and even that was significantly less than the 3.9% in the second quarter. (Source: “Gross Domestic Product: Fourth Quarter and Annual 2015 (Advance Estimate),” Bureau of Economic Analysis, January 29, 2016.)
Analysts previously touted the strength of the U.S. jobs market as a sign that the U.S. economy is doing fine. Or better than fine, as the pillar of strength for the U.S. economy. That pillar took a bit of a hit last Friday, though, after weak U.S. jobs numbers came out.
The U.S. economy added 151,000 jobs in January, far below the 190,000 forecasted. It’s going to be tough for the Federal Reserve to continue to raise its key lending rate amidst signs of a weakening economy. (Source: “Unemployment Situation Summary,” Bureau of Labor Statistics, February 5, 2016.)
And the U.S. economy is weakening. The International Monetary Fund (IMF) reduced its outlook for the U.S. to grow at just 2.6% this year and next. This is lower than the previously forecasted growth of 2.8% for both years. (Source: “Subdued Demand, Diminished Prospects,” International Monetary Fund, January 19, 2016.)
The World Bank also tossed up some weak numbers for the U.S. economy. In 2016, the economy is projected to increase 2.7%, 2.4% in 2017, and 2.2% in 2018. Declining numbers do not point to solid growth. (Source: “Global Economic Prospects,” World Bank, January 6, 2016.)
Those numbers all point to growth and not a recession. However, steep declines in oil prices, primary job cuts from the industry, and secondary job cuts from those affiliated to the industry could bleed into the larger economy, taking consumer sentiment down with it.
The final reading of the University of Michigan’s consumer index for January came in at 92, a significant drop from 93.3 earlier this month. It’s also down from 92.6 in December. Again, not a great sign for a country that gets more than 70% of its GDP from consumer spending. (Source: “Survey of Consumers University of Michigan,” University of Michigan, January 29, 2016.)
U.S. Economy Is Not an Island
The U.S. is not an economic island. As a result, global economic conditions will have a material impact on the U.S. economy and, in turn, the stock market. The world is interconnected, so when the world’s biggest economy and China, the world’s second-biggest economy, falter, there will be repercussions.
Japan, the third-largest economy, recently introduced negative interest rates. Canada may introduce negative interest rates to prop-up its floundering economy soon, too. This follows a long list of other countries that have initiated negative interest rates in an effort to kickstart the economy—something quantitative easing (QE) was supposed to do, but clearly didn’t.
In 2015, central banks in Europe, including the Danish, Swedish, and Swiss banks, cut their short-term rates to below zero. In 2014, the European Central Bank (ECB) cut its rate to below zero.
Despite these financial tricks from central banks, the global economy does not look good. If anything, the world is on the brink of a global recession. The IMF lowered its outlook for the global economy to 3.4% in 2016 and 3.6% in 2017. The World Bank cut its global growth outlook for 2016 to 2.9% from its June 2015 projection of 3.3%.
Could negative interest rates happen in the U.S.? The Fed just raised its lending rate for the first time in nearly a decade. A move to negative rates would be unusual, but so, too, is $3.5 trillion in QE to help the economy and artificially low interest rates. If the global economy continues to falter, the Fed might have to examine the idea of negative interest rates.
Keep in mind that negative interest rates are supposed to encourage spending. Negative interest rates also have the adverse effect of destabilizing investor confidence. Again, not something the stock market can really handle right now.
That’s especially true when you consider the list of world indices already in bear market territory: Canada, China, Germany, Japan, England, France, Spain, Sweden, Russia… These aren’t small economies either. Again, China is the second-largest economy in the world, followed by Japan, Germany, the U.K., and France. The FTSE 100 is not in bear market territory, but it is flirting with it.
Why is all of this important? The percentage of S&P 500 sales coming from outside the U.S. is increasing. It was 47.82% in 2014, up from 46.29% in 2013, and 46% for each of the previous four years. (Source: “S&P 500 Global Sales 2014,” S&P Indices, July 2015.)
The global economy is intertwined and it’s a mess. And the U.S. economy is not doing as well as we think. Somehow, 2016 could be the year the U.S. economy surprises analysts and falls back into a recession.