Tags: earnings | recession | economy | profits

Is the 'Earnings Recession' Over?

Is the 'Earnings Recession' Over?

(Dollar Photo Club)

By    |   Thursday, 10 November 2016 02:56 PM EST


After five consecutive quarters of earnings declines, the collective stocks of the S&P 500 are showing positive growth as we near the end of the third quarter of earnings season. While the numbers aren’t final yet, it looks like earnings will grow around 2 percent this quarter.

That’s off a 2.8 percent decline in the second quarter of the year. And in the first quarter, a 6.6 percent decline. And a 6.0 percent decline in the fourth quarter of 2015, a 1.8 percent decline in the third quarter of 2015, and a 2.2 percent decline in the second quarter of 2015.

In other words, while earnings growth has become positive again, we still have a long way to go to get back to peak earnings for the market as a whole.

Will we get there? Of course we will, but it’s a matter of time. What’s more important is how stocks have performed during this earnings recession. And overall, they’ve held up well. There have been some modest pullbacks in the past few years, but after a 10 percent decline stocks have come roaring back.

Valuation remains high, and declining earnings amidst a flat market makes stocks look even more expensive. But now that the market is shifting back towards growing earnings, a flat market performance could mean that stock valuations will come down.

This isn’t the first time we’ve seen a bizarre pattern in the markets obscured by price. In the heyday of the 1960’s, stocks soared, both in terms of pricing and in terms of valuation. They soured with the rising inflation and oil shocks of the 1970’s. Between 1968 and 1980, the Dow gained a single point—a full twelve years where stocks made a round trip to nowhere. But since earnings held up overall, stock valuation was much better at the start of 1980 than it was during a mid-term market peak in the late 1960’s.

For me, the poster child for this quarter’s earnings have been from tech giant Microsoft (MSFT). It’s an older tech play, not a fast-moving social media company. But the company’s revenues have been surging, and the company’s share price recently soared past its 2000-tech-bubble peak.

Back then, Microsoft traded at over 70 times earnings. Today, at the same valuation, it only trades at 28 times earnings. And it pays a 2.6 percent dividend, something that would have seen crazy back in the dotcom era. It’s a bit of a different company, but it’s also a very different market that’s led to a lower valuation at prices last seen during a major bubble.

At the end of the day, it remains to be seen whether improving earnings will lead to higher stock prices. If it doesn’t, the market’s valuations will come down from historically elevated (but below bubble) levels. That could also give the stock market the buffer it needs to deal with a rising interest rate environment. I still expect the Fed to raise interest rates by another quarter point. With an improving earnings outlook, the market could easily handle such a move without the big selloff we had following last December’s interest rate hike.

I tend to view the market in terms of being cautiously optimistic. Over time, it pays to be invested in stocks over bonds or cash. If earnings are going up on average, that case just got stronger, especially following five quarters of declines on average.

Just keep in mind that there are a few issues that could still impact markets. Energy prices are a big one. The collapse in oil prices two years ago seems to have hit the bottom earlier in the year when oil dropped under $30. Now oil seems more likely to trade in a range between $40 and $50 while OPEC rumors swirl and production levels show a trend towards supply and demand equalizing.

This could be an opportunity for investors and traders alike: buy major integrated oil companies when the price of Texas Tea is close to $40 and take profits when oil heads back to $50. Or buy low and keep collecting the dividends. Again, I wouldn’t stray too far from some of the big names in the space like ExxonMobil (XOM) or ConocoPhillips (COP).

Likewise, another factor that could act as a wild card in future earnings seasons is the US dollar. It’s been on a strengthening trend in recent years, which has weighed on the profits of US-based multinational companies. These trends don’t last forever. More importantly, the long-term trend of the dollar is down against other currencies. We should eventually return to that trend. When we do, profit margins at multinationals should improve.

Is there an opportunity here? Most likely, although investors tend to pay full valuations for consumer goods companies on average so the bargains are rarer. That said, two years ago, the strengthening dollar meant U.S. investors could buy foreign consumer goods companies like Unilever (UN) instead of Procter & Gamble (PG) to get the best returns. A shifting trend towards a weaker dollar means the trade should likewise be flipped, with U.S. multinationals taking a larger portfolio position compared to international ones.

So is the earnings recession over? For now, it seems. Just remember that there will always be recessions. But after some brutal declines in the preceding five quarters, it’s a welcome respite. There are still a lot of unknowns out there. So what? There will always be unknowns when investing. Valuations remain high, but as long as corporate earnings continue to grow, stock will look like the best game in town. In short, this market likely still has legs. Don’t worry too much about big daily swings, it’s earnings that matter over time.

Stick with high-quality names and focus on companies that can deliver income generation. Just as today’s Microsoft is a better bargain than it was at the same price in 2000, today’s market is different as well. Ignore it at your financial peril.

Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and is managing editor of Financial Intelligence Report.

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After five consecutive quarters of earnings declines, the collective stocks of the S&P 500 are showing positive growth as we near the end of the third quarter of earnings season. While the numbers aren’t final yet, it looks like earnings will grow around 2 percent this quarter.
earnings, recession, economy, profits
Thursday, 10 November 2016 02:56 PM
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