The previous two weeks have provided a good amount of economic data and we’d like to spend some time summarizing the information and looking ahead into the summer months. Now that 90% of S&P 500 companies have reported earnings for Q1 2016, we can look back on the data and glean a little more insight into the health of corporate profits as we move into Q2. Oil’s rebound seems to have stalled at the end of April alongside falling U.S. rig counts, an upheaval in the Saudi oil ministry, and downward trending U.S. output. After reaching a high of nearly $47 a barrel, light sweet crude (June contract) has settled back down to about $43 a barrel. Inventory continues to be the dominant theme, but low global growth fears (stoked by recent Chinese debt concerns) haven’t helped the energy landscape.
Speaking of Chinese debt concerns, we profiled EBIT-debt coverage in a January briefing room post and the Telegraph recently wrote about the continued angst over the level of Chinese corporate debt that has reached 175% of GDP. More worryingly, however, is the explosion of debt within emerging market countries:
The highlight, as The Telegraph cites from a report by the Institution of International Finance, is the interconnected nature of this emerging market corporate debt bubble and Fed policy here at home. Could it be that the most concerning aspect is not so much the level of debt, but rather the beggar-thy-neighbour situation we potentially find ourselves in if inflation begins to run hotter than expected and the Fed must tighten to keep the train on the tracks? As the articles continues,
(Source: The Telegraph)
However, as the most recent inflation data shows, we don’t believe we’re in any imminent danger of inflation getting out of hand as we hit the halfway point of 2016:
(Source: Advisor Perspectives)
The sharp spike we saw in the early months of 2016 are largely attributable to the volatility components in the CPI basket, like food and energy. You can see the muted response from the core components in the chart above once those factors are stripped away. There may be underlying strength in the inflation numbers, but the recent jump earlier in the year seems to be exaggerated. As such, we believe that the Fed will continue to pay more attention global risks with the understanding that inflation has room to run here in the U.S.
As we turn to corporate profits, FactSet reports that the blended earnings decline for Q1 2016 is -7.1% — the largest year-over-year decline since 2009 and the fourth consecutive quarter of year-over-year declines (the last time this happened was Q4 2008 through Q3 2009). The glass-half-full perspective is that this decline is less than the expected earnings decline of -8.7% at the end of the quarter (March 31). However, that’s not a very convincing argument for the health of the S&P 500 constituents. In fact, the blended sales decline was larger than expected (-1.6% vs. -1.0%), and is the fifth consecutive quarter of declines. We continue to see a decoupling between S&P 500 price and forward earnings per share:
With a tepid 0.5% annual increase, the Q1 GDP number doesn’t provide much reason for excitement. However, the first revision is due at the end of May, so we’ll see what sticks as summer approaches. The housing market, the U.S. consumer, and state/local government spending all propped up growth in the first quarter, although personal consumption has slowed through the year. Speaking of the housing market, mortgage credit continues to tighten (indicated by the downward trend in the chart) as we enter a seasonally strong period of sales.
(Source: Mortgage Bankers Association)
Summer is historically a volatile season, and the upcoming political conventions and the Brexit vote aren’t going to smooth out the waters for investors. Global growth continues to be underwhelming, Japan’s negative interest rate policy seems to be doing a good amount of nothing, Chinese debt concerns are bubbling to the surface, and corporate defaults are beginning to mount up. As we enter the warmer months, we want to make sure our clients keep their cool when it comes to long-term investing. We’re focused on the downside risks, and we believe that portfolios should be aligned to both objective and a quantified risk tolerance. If you would like more information about how we can help you, please reach us at info@targetedwealthsolutions.com
—
The information presented here is for informational purposes only, and this document is not to be construed as an offer to sell, or the solicitation of an offer to buy, securities. Some investments are not suitable for all investors, and there can be no assurance that any investment strategy will be successful. The hyperlinks included in this message provide direct access to other Internet resources, including Web sites. While we believe this information to be from reliable sources, Targeted Wealth Solutions LLC is not responsible for the accuracy or content of information contained in these sites. Although we make every effort to ensure these links are accurate, up to date and relevant, we cannot take responsibility for pages maintained by external providers. The views expressed by these external providers on their own Web pages or on external sites they link to are not necessarily those of Targeted Wealth Solutions LLC.