This week we finally witnessed the equity markets owning up to a well known reality; earnings matter! We've been warning for several months that second quarter earnings for the broad market (S&P 500) were expected to decline.
As of June 30, according to FactSet, earnings were expected to decline by -4.5%.(i) The "good-bad" news is earnings on the 187 companies that have reported to date have reported declines of only -2.2%.(ii)
Markets reacted accordingly with an appropriate pull back of 2.25%.(iii)
What's likely the biggest surprise is guidance coming out of S&P 500 companies for Q3 2015. Companies continue to guide both earnings and revenue down and actually into negative territory. Again from our friends as FactSet.(iv)
The earnings themes from the reports I have read (I try to read about 20 or 30 reports a quarter to gain a general perspective) are as follows:
- The strength of the US Dollar compared to this time last year is causing earnings to contract by approximately 400-800 bps. It's quite entertaining hearing how CEO's are trying to frame the damage. Words like "Organic Earnings and Constant Dollar" are often messaged in their conference calls.
- Companies that are mostly focused on the United States have much stronger earnings and revenue.(v)
When you factor out energy stocks and foreign currency issues from earnings you see companies growing earnings by 8.3%. This is much closer to the long term (55yr) EPS growth average of 8.14%.(vi)
- Financials are looking like the strongest sector at this point in the earnings cycle. Much of their mortgage litigation is behind them and cost cuts are paying off with improving margins; even in the face of very low interest rates.
- The US Consumer is gaining in confidence to the point of borrowing to buy. Bankcard credit expanded 1.5% month over month and is up 4.5% year over year.(vii)
So what's an investor to do?
Don't panic and run.
Take a hard look at sectors like commodities and MLP's as they are all facing unique headwinds.(viii)
Commodities and Precious Metals- the strong dollar and continued easing policies from the EU and China are not creating a gold rush, but a rush to the US dollar.
MLP's generally work well in rising rate environments but with a global glut in oil, the correction in MLP's may be a little longer and deeper than expected.
Realize you can't time markets with enough consistency to profit over the long-term. Raising some cash to deploy as values contract is one thing, but trying to time your exit is another matter. Take a look at this slide from our Q3 2015 Look Ahead.(ix)
With the US Consumer gaining confidence "organically" and if the equity markets only correct "normally" between 5-10%, we could see this earnings contraction cycle only last a couple of quarters; which means a return to the rally.
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Tim Phillips, CEO – Phillips & Company
(i) FactSet Earnings Insight - July 2, 2015
(ii) FactSet Earnings Insight - July 24, 2015
(iii) INDEXSP:.INX- July 20-24, 2015
(iv) FactSet Earnings Insight - July 2, 2015
(v) FactSet Earnings Insight - July 24, 2015
(vii) Credit Forecast, Household Credit - July 24, 2015
(viii) Alerian MLP - July 25, 2014 - July 24, 2015
(ix) Phillips and Company Q3 2015 "Look Ahead"