With the first quarter of 2015 behind us, it’s corporate earnings reporting season. Unfortunately, we are expecting the biggest decline in public corporate earnings since 2009.
Corporate Earnings Expected to Decline
Corporate profits are the most basic reasons why key stock indices rise or fall. If earnings are rising, stocks usually rise. If earnings are declining, stocks regress to the mean and decline in price.
With that said, for the first quarter of 2015, year-over-year earnings of the S&P 500 companies are expected to decline by 4.6%. This will be the biggest decline in earnings since 2009! (Source: FactSet, April 2, 2015.) Looking at this, I don’t know how one can possibly risk buying stocks right now.
This isn’t all; revenue is expected to decline big-time as well, falling 2.7% in the first quarter of 2015. Declining revenue means companies aren’t able to sell more—it also tells us that demand in the economy is declining.
Valuations Remain Extremely Stretched
Weak earnings aren’t the only reason why investors should be careful. The optimism and misallocation of capital also suggests stocks are a dangerous place to be.
A tool I use to gauge the stock market valuation is the price-to-sales multiple. Simply stated, this multiple is how much investors are willing to pay for each dollar of revenue a company generates.
As it stands, in April of 2015, the average price-to-sales multiple of all S&P 500 companies stands at 1.80. This means that for every one dollar of revenue, investors are willing to pay $1.80. This is the highest number since at least the year 2000! (Source: Multpl.com web site, last accessed April 8, 2015.)
Mind you, 1.8 is the average. If you look at certain sectors and companies, investors are paying way beyond this amount. Saying the least, the extent of investment fund misallocation, as I see it, is massive.
Hence, we have three negative factors at work now: falling corporate profits, a contraction in corporate revenue, and a sky-high price-to-sales multiple.
Federal Reserve Worried?
Furthermore, and I have said this before, investors are too complacent about the global economic slowdown. They don’t care about what’s happening outside the U.S., which is a mistake.
But the Federal Reserve is worried about it. In the most recent meeting minutes of the Federal Open Market Committee (FOMC), it states, “Participants pointed to a number of risks to the international economic outlook, including the slowdown in growth in China, fiscal and financial problems in Greece, and geopolitical tensions.” (Source: Board of Governors of the Federal Reserve System, April 8, 2015.)
Know this: Companies on the key stock indices have significant operations outside of the U.S. If the global economy continues to face headwinds, their revenues will slow and eventually, their profits will take a hit.
What’s Really Ahead?
I believe in buying when nobody wants to buy. Currently, the stock market looks way overpriced to me…and investor optimism is at extremes. For the first three months of 2015, the key stock indices remained flat. For 2015, I’m expecting negative returns for stocks, as the risks of owning stocks are increasing each day, while the upside potential is very little.