When it comes to the stock market, 2015 will be remembered as a year of corrections and flash crashes. Yet despite the frenetic year on Wall Street, fears of an interest rate hike in the U.S., and a struggling global economy, the S&P 500 and Dow Jones Industrial Average continue to trade near record-highs. So-called misguided fears about a recession in the U.S. and global economies in 2016 may not be so erroneous after all.
S&P 500 and DJIA Defy Logic
Thanks to artificially low interest rates, the broader stock markets marched steadily higher between 2009 and 2014. This year was a different story, though—not as different as it should have been, but it was a transitional year of sorts.
In 2015, investors fretted about rising interest rates and weak economic indicators both here and globally. Despite concerns that gave rise to corrections and flash crashes, optimistic investors continued to keep the stock markets at lofty heights.
Between March 2009, when the markets bottomed, and the end of 2014, the S&P 500 soared 200%; this year however, the S&P 500 is up just 1.5%. Over the same timeframe, the Dow Jones Industrial Average climbed 175%; this year, it is up 0.01%.
What’s most amazing is not that the S&P 500 and Dow Jones Industrial Average have barely eked out any gains, but that they continue to trade near record-highs.
S&P 500 Profits Disappoint in First Three Quarters
Earnings from S&P 500 companies have dropped by around $25.0 billion in the first three quarters of 2015. The hit to profits comes on the heels of low oil prices, a weak global economy, and a strong U.S. dollar. Add to this picture a bleak outlook for the fourth quarter and a further drop is likely for the year as a whole.
So far, around 481, or 96%, of the S&P 500 companies have reported their third-quarter results. Their combined net income from continuing operations for the first three quarters is $804 billion. In comparison, during the first nine months of 2014, total net income from continuing operations was $828 billion. (Source: “S&P 500 Profits Fall $25 Billion in First Three Quarters of 2014,” Bloomberg, November 23, 2015.)
What about year-to-date revenues, you may be wondering? The aggregate revenue for S&P 500 companies is down $287 billion compared to the same period in 2014.
On a share-weighted basis, profits at S&P 500 companies were down 3.3% in the third quarter. This marks the second consecutive quarter of negative earnings growth and the worst earnings season since 2009—a technical profit recession!
How do investors respond? In a seesaw year, the S&P 500 currently trades 16.2 times (X) its forward earnings. This is just slightly below the 16.3X at which it traded at the end of 2014.
The big question is how much worse is it going to get and how long can investors keep it up? The future doesn’t exactly look bright for the global economy. According to the International Monetary Fund (IMF), global growth is projected to register at just 3.1% in 2015, down from 3.4% in 2014. Global growth of 3.6% is expected in 2016, but chances are good, if history is any indicator, that this will be revised lower in the coming months, especially in light of a strong U.S. dollar. (Source: “Global GDP Worse Than Official Forecasts Show, Maersk Says,” Bloomberg, November 8, 2015.)
A strong dollar isn’t exactly a great sign for growth when you consider that almost half of all the companies listed on the S&P 500 get at least part of their earnings from Europe (which is barely growing), Japan (experiencing moderate growth), and China (slowing). You can add to the picture Russia and South America as write-offs.
Strong U.S. Dollar Hurting Dow 30 Companies
Not surprisingly, the Dow Jones Industrial Average is also posting some solid, abysmal numbers, particularly when it comes to Europe.
Of the 30 companies on the Dow Jones Industrial Average, 11 announced revenue data for Europe in the third quarter. (Source: “Earnings Insight,” Factset.com, November 20, 2015.) Of those 11 companies, nine reported a year-over-year decline in revenues. This number echoes the number of DJIA 30 companies that reported a year-over-year sales decrease in the second quarter. For seven of these Dow companies, the third quarter marked at least the third consecutive quarter of year-over-year declines in revenues from Europe. Finally, all 11 companies cited some negative impact on revenues and earnings in the third quarter as a result of the strong U.S. dollar.
The case is illustrated quite nicely by 3M Company (NYSE:MMM): “Foreign exchange impacts reduced sales by 7.4%, with notable year-on-year declines in the euro, yen, and Brazilian real. These currencies devalued versus the U.S. dollar by 15%, 14%, and 37% respectively.” (Source: “Transcript of 3M Earnings Conference Call,” Yahoo! Finance, October 22, 2015.)
A strong U.S. dollar is great for Americans on vacation. Companies on the S&P 500, on the other hand, will be feeling the effects of a strong U.S. dollar for a long time and earnings will continue to be underwhelming as a result. Will investors notice, though, before it’s too late?
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