U.S. Markets Not as Strong as They Seem
Despite the fact that the S&P 500 and Dow Jones Industrial Average are trading near record highs and investors are enjoying a bull run that is now in its sixth year, the fact of the matter is that the stock market is not as strong as it appears.
Remember that the stock market is only as strong as the stocks that go into making up the exchange. Many economists believe the stock market rally has been fuelled almost exclusively by the Federal Reserve’s easy money policies, namely its bond buying program, and not by strong revenue and earnings growth.
For example, in 2013, the S&P 500 climbed almost 30%, but it did so against a backdrop of weak earnings. In each successive quarter of 2013, a larger percentage of companies revised their earnings guidance lower. During the first quarter of 2013, 78% of S&P 500 companies that provided pre-announcements issued negative earnings guidance; that number climbed to 81% in the second quarter, 83% in the third quarter, and a record high 88% in the fourth quarter.
Stock Prices Being Propped Up
How, then, have companies been able to report solid earnings growth? They’ve been able to prop up their earnings through financial engineering; that means cost cutting measures and aggressive stock repurchase programs.
For example, a company can make the same money this year as it did last year, but if it buys back 10% of its stock this year, last year’s earnings of $3.00 a share will become $3.30 a share this year.
And a lot of companies are issuing negative earnings guidance and buying back stock. For the first quarter of 2015, 80% of companies that have issued earnings guidance have announced a negative outlook. Back in September, the estimated earnings growth rate for the first quarter of 2015 was 9.9%; by the end of December, it had slipped to 4.2%, and it now stands at -1.6%.
According to the most recent data, S&P 500 companies spent $143.4 billion on share repurchases in the third quarter of 2014, which was a year-over-year increase of 16%. On a trailing 12- month basis, S&P 500 companies spent $567.2 billion on share repurchases, making for a year-over-year increase of 27%.
Poor economic numbers are starting to impact the S&P 500, where the average fourth-quarter revenue growth for S&P 500 companies was just 1.4%.
Why do companies have to massage their quarterly results? Because Americans are tapped out: personal debt levels remain high, wages are stagnant, and underemployment remains stubbornly high at above 11%. On top of that, 46.5 million Americans, or 15% of the population, receive food stamps, a 75% increase from before the financial crisis. For a country that gets 70% of its GDP from consumer spending, these are not encouraging numbers.
Global Economy Struggling
And it’s not just the U.S. that is struggling. The IMF said that weak trajectories in China, Russia, the eurozone, and Japan will hold world GDP growth to just 3.5% this year and 3.7% in 2016. China, the world’s second-biggest economy, is predicting the slowest growth rate in 23 years.
Russia is headed for a recession in 2015 at -0.3%, and then -0.1% in 2016. The eurozone, the world’s biggest trading region, is expected to grow just 1.2% this year and 1.4% next year, while Japan’s economy will grow just 0.6% in 2015 and 0.8% in 2016.
The global economy is also witness to a number of geopolitical tensions in Russia, Ukraine, and the Middle East. If the U.S., the world’s biggest economy, and the Eurozone, the world’s largest economic region, fall back into a recession, the North American markets could experience a very serious correction.
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“Earnings Insight,” FactSet.com, January 30, 2015; https://www.factset.com/websitefiles/PDFs/earningsinsight/earningsinsight_1.30.15.
“Buyback Quarterly,” FactSet.com, December 16, 2014; https://www.factset.com/websitefiles/PDFs/buyback/buyback_12.16.14.
“Supplemental Nutrition Assistance Program Participation and Costs,” United States Department of Agriculture web site; https://www.fns.usda.gov/sites/default/files/pd/SNAPsummary.pdf, last accessed February 9, 2015.
Handley, P., “IMF slashes 2015-2016 world growth forecast,” Yahoo! News, January 20, 2015; https://news.yahoo.com/imf-slashes-2015-2016-world-growth-forecast-032616123.html.
Walker, A., “IMF downgrades global growth forecast,” BBC web site, January 20, 2015; https://www.bbc.com/news/business-30876954.