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While any parent can tell you that giving your kids some cookies will certainly keep them happy for a while, but you know deep down that it is not the ultimate solution for whatever ails them and that a diet of cookies is in no one’s best interest. Stock and bond markets are also, in my view, on this same kind of ‘sugar high.’ No one seems too concerned about how these vast debts ever get repaid or how we can’t have every major country trying to depreciate their currencies to stimulate growth at the same time. Over five year’s worth of zero-interest rate policies and global growth is still only staggering along at a 3% rate. In fact it looks like growth might be waning a bit again. The ISI Survey numbers that we follow very closely have been heading lower in the U.S. over the past six months, more than offsetting any minor recovery in Europe. Meanwhile, Chinese growth continues to wind down as the massive capital spending initiatives put in place since 2008 have only lead to masses of ‘empty cities and roads to nowhere.’ After the Chinese economy witnessed the greatest expansion of credit in history since the crisis, built too much capacity and are now experiencing deflation, what is their solution? In the past month they lowered reserve ratios so that the banks can lend even more money into the economy! The policy-makers across the globe all seem to have only ‘one arrow left in the quiver’, and it’s the same one in each case; more easy money.
One key indicator of where global growth is headed is the move in commodity prices. The chart below shows the ‘Commodity Growth Rate Index’ since 2007. After seeing a sharp recovery following the financial crisis, it headed lower again in 2011 when the financial problems in Portugal, Ireland, Italy, Greece and Spain (remember the year of the PIIGS?) lead a collapse in commodities. Markets then stabilized as US growth recovered but the indicators have once again turned negative in the past 6 months, driven in large part by the collapse in oil prices. But copper, iron ore, met coal, natural gas and other key commodities have also been under severe pressure as supply remained strong as demand weakened.
The strong US dollar and the associated decline in commodities and pricing power has contributed to a significant decline in 2015 earnings growth expectations for the S&P 500. The bottom-up consensus for 2015 earnings growth peaked at 12.5% in September and has since declined to 1.8% growth for the year. The energy sector has seen the greatest downward revisions, which is no surprise given the collapse in oil price. This is followed by multinationals, which are lowering their guidance due to the negative impact of the stronger US dollar. Most recently we heard from Hewlett Packard which lowered their guidance for 2015 for that very reason. So far this year, the financial sector is the only area recording (small) net upward revisions to the 2015 growth outlook, and not because 2015 was revised up but rather because 2014 earnings were disappointing. Forward earnings estimates have declined by 5.2% since peaking in October. This is the biggest decline in forward earnings outside of recession in the 35 years of available data! The chart below shows the Thomson Reuters consensus earnings estimates for the S&P500 for both 2014 (blue line) and 2015 (gray) tracked in time across the last year. As a preface, we recognize that analysts tend to be an overly optimistic group to start with as they get much of their information from similarly cheerful company executives who always expect ‘next year to be better.’ As reality starts to set in, then earnings estimates drop and the lines are almost always trending downward. 2014 was another such case as the initial estimate for the year started at around $132 and the final number came in around $117; still decent growth but clearly not as good as expected. The 2015 estimate was running around $136 back in the summer of 2013 and was still hanging in around $133 last summer. Due to the impact of a rising US dollar and falling oil prices, the estimate has collapsed in the past six months and is now just $122 for the full year, suggesting that earnings growth will only be about 4% in 2015. And we’re still only in February!
