Spring has sprung across the U.S. and seems to have put some spring in the markets; with major stock markets across the globe enjoying positive returns for the month of April. On April 23rd, the NASDAQ finally crossed past its previous high from March of 2000. It was a welcomed improvement from the sideways environment of the first quarter of the year, but focus has returned to earnings; in addition to the Fed, the strong dollar, and low oil prices. Let’s start out discussing earnings reported so far this year and then step back and look at the economy here in the U.S. and abroad.
At the time of this writing roughly half of the S&P 500 companies have reported earnings. There has been growing concern that a strong dollar would impact large multi-national companies who have to bring profits back to the U.S. Many companies have reported this issue in their earnings conference calls, among them Johnson & Johnson, Intel, Walgreens, General Mills, Oracle, FedEx, and the list will surely grow longer.
This chart shows that the companies who have 50% or greater non-U.S. sales are experiencing worse earnings growth compared to companies who sell more products in the U.S., and how the strong dollar is impacting revenues for global businesses.
Oil is also a big factor, and looking at the earnings of specific sectors within the S&P 500 it is probably no surprise the energy sector is reporting the largest year-over-year decrease in earnings due to low oil prices. Interestingly, if we were to exclude the energy sector from the S&P 500, we would see the estimated earnings growth rate jump to 5.6% from -2.8%.
The largest company in the S&P 500 is none other than Apple (AAPL), and in late April they reported their Q1 earnings. Shareholders waited with bated breath to hear that Apple beat earnings estimates by $.17 per share. Along with Apple’s earnings news came an announcement they would increase their buyback from $90b to $140b, as well as increase their dividend. Tim Cook, CEO for Apple, said they are bringing in far more money than they need, hence the dividend increase and stock buyback.
Why do we so closely examine this one case? The answer is in sales. Apple revenues were up 27.1% year-over-year from sales of the iPhone, Mac, and revenue from the App store. Apple is experiencing tremendous success; however, if we look back to the broader set of companies that have reported earnings we see that over half are missing analyst sales estimates. Healthcare, as a sector, is reporting the highest growth in sales, and Consumer Staples has the highest percentage of companies’ beating sales estimates. However, for the remainder of the year analysts expect year-over-year declines in earnings and revenues for the next two quarters, and then they expect growth to return in the Fourth Quarter.
We’ve discussed the Price-to-Earnings (P/E) multiple in recent newsletters, and it is worth revisiting to make a point about the importance of sales. The 10-year average “forward” P/E multiple for the S&P 500 is 14.1, meaning if XYZ Company’s next 12 months of earnings were expected to be $2 then XYZ’s stock price would on average be around $28.20 per share. The current forward P/E for the S&P 500 is 17.1, and we can fairly say these stocks are slightly over-valued relative to historic norms. The main point here is the stock market does not have a lot of room to move up based on simple P/E multiples.
There must be strong sales in addition to strong earnings to justify higher stock prices.
While analysts might expect a couple of weaker quarters for corporate earnings, the American consumer has a lot to be happy about for the most part. The dollar is strong so he or she can buy more goods. Low oil prices translates to lower gas prices. This chart shows us that inflation is relatively low to non-existent. Put those conditions together and most would expect to see more spending.
However, on April 29th, the U.S. Department of Commerce published its first estimate for First Quarter GDP, and it was a paltry 0.2%. Similar to last year, the economy has gotten off to a sluggish start which some attribute to weather. Based on the economic data recently reported, many feel the Federal Reserve voting members will push back their first rate hike. The Fed statement released on April 29th removed all references to the calendar, and a move could potentially happen at the next meeting, but most indicators point to later this year if not 2016.
Europe, China, and Japan have all experienced strong stock gains in April, as well as year-to-date. Europe continues to work its way out of recession; however, the possibility of a Greek Exit is again back in focus. Greece is such a small country relative to the other European Union members, and most expect a potential exit to be manageable. China continues to work towards establishing the yuan as a global reserve currency. China has also lobbied to the International Monetary Fund to join the elite status of the U.S. dollar, the euro, and the Japanese Yen as a reserve currency. Additionally, the Chinese have also created a stock market that now accommodates individual and international investors, and it is possible that the Chinese amateur investor has helped to drive up Chinese stock prices. Chinese investors opened nearly 5 million trading accounts in March, alone.
We continue to monitor all of these developments closely, and some of these issues are temporary. The dollar will remain strong on the near term, but no one expects that to be constant forever. The price of oil is low, however that too will eventually change as production and demand stabilize. However, if those two factors remain constant on the near term, as does consumer sentiment, then you can make a case for improving sales and stock prices as we work our way through 2015.