Investors may not have realized but something interesting happened in the third quarter of 2015; corporate earnings declined year-over-year in the July-September quarter for the first time since July 2009.
While one quarter doesn’t show a trend, earnings quality going forward doesn’t certainly look good, said Larry McDonald of Societe Generale. Financial engineering by S&P 500 companies have been stretched to the limit through tax inversions, buybacks and dividend payouts; they generated a ton of earnings momentum over the last three years, pushing valuations to a record high.
But now markets have reached to the point where valuations are “at the bone” and the quality of earnings is progressively getting worse, he noted.
The movement of the S&P 500 index portends to a slowing earnings growth and signals the tail end of a six-year old bull-market which began in March 2009, said Rich Ross of Evercore ISI.
The slowdown is clearly becoming an issue and it’s borne-out by the year-to-date chart which shows benchmark index has been largely trading sideways for the better part of the last 18 months. The index is just up 1.0 percent on YTD basis despite all of the volatility and has been range-bound between 2,135 on the high-end and 1,875 on the low-end.
The S&P 500 index has held the 150-week moving average, which has defined the trend for the last five years. Clearly, on a break below that 150 week average, the index may come down some 8-10 percent, which would signal the end of the primary bull-market.
While equities have not reached that point yet, there could be a case where markets may re-test those levels in the short to intermediate-term, i.e. over the next three to six months. The markets may see very strong seasonality in November and December, which causes investors to look past the myriad of more telling macro economic concerns that are out there vis-à-vis the stronger dollar and weaker commodity.
So, as it portends to the S&P, slowing earnings are an issue when the chart is in stall-speed, as indicated by the trading range at the tail-end of a very old bull-market in need of some correction. The market has been narrowing recently, crowding into fewer and fewer large-cap stocks.
US markets are facing the prospect of higher interest rates along with a stronger dollar, which is not a great backdrop. Furthermore, if slowing earnings are brought into the equation, investors are certainly looking at some serious issues once they get past the season of strong seasonality, he explained.
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