The Global Markets Weekly – 10/24/16

Posted October 24, 2016 by rvillareal

End to U.S. Profits Recession?[private]

The third quarter corporate reporting season will be in full swing this coming week, with nearly 200 reports due from the S&P 500, updating results across a comprehensive set of technology, consumer-focused, and industrials firms, plus heavyweights in the energy sector. That will give a better handle on whether the S&P 500 ekes out a positive annual gain for the first time since the first quarter of 2015.

Protracted declines in corporate profits have historically accompanied recession, with the exception being a downturn in earnings during the mid-80s. That one exception, of course, has been a better guide as a parallel than a naïve look at aggregate profits growth might have suggested. It also coincided with a period of oil price declines driven by a surge in supply. The earnings impact was surely real in an accounting sense, but the economic offsets of cheaper energy as a consumer tailwind were, and are, more important. The parallel ends there, as hopes of matching the ensuing decade and a half of market and economic gains is quite unlikely, given the initial conditions on interest rates, debt, and demographics are far different.

The current season has so far been defined by sharply better than expected results in Financials, helped by base effects and trading activity, cost cuts, and probably more importantly, no fresh negatives. In other sectors, expectations remain intact but mixed and modest, still weighed down to some extent by energy drag and dollar headwinds. Earnings ex-financials-energy-and-materials never quite turned negative in recent quarters on DE tracking, and revenue growth has generally outpaced earnings, but has decelerated to a low-to-mid single digit range.

An end to the profits recession and modest growth into 2017 would turn down the volume even further on a key risk that DE has been monitoring—a potential self-reinforcing cycle of weaker profits and investment that would spill over into hiring. Instead, net hiring has held up well, and in an environment of gradually rising wages. Other key risks have diminished as well, including China slowdown and Brexit.

Where to from here? Continued economic expansion in the U.S. and abroad will provide underlying tailwinds, which we expect Q3 real GDP data to indicate this week. We will be monitoring wage pressures and dollar impacts on the bottom line, and the tradeoffs of accelerating inflation being a positive for sales, but a negative for the interest rate outlook. A rebound in energy sector EPS in coming quarters will exaggerate the “true” underlying rate of earnings growth as 2017 rolls into view, much like declines exaggerated weakness. A slower trend pace of GDP growth plus so-far modest inflation should anchor growth in a conservative range on average in 2017 and 2018, in the mid-single-digit range.

• S.: The highlight is advance Q3 real GDP (Fr), preceded by Sep. durable goods orders (We). Fed speakers hit early and often in the pre-meeting blackout period, Dudley, Bullard, Powell, and Evans (all Mo), plus Lockhart (Tu) due to appear.
• Eurozone: It will be interesting to if the robust business and consumer surveys data the ECB talked about in September continue in the array of updates due this week starting with the flash PMIs on Monday. In addition, and perhaps more interesting will be whether monetary data on Thursday offer more even more signs of an improving policy transmission mechanism.
• UK: The conflicting message of survey and hard data of late puts more emphasis on the allegedly stand-out piece of data this week, namely the Q3 GDP preliminary estimate on Thursday. The hard output data, on which this version of GDP will be based, suggest that growth continued last quarter, with no sign of the immediate post Brexit vote slump into recession that some had feared.
• Japan: September trade data (Mo) and the monthly report on consumer prices (Fr) will be the highlights ahead of the following week’s BOJ meeting. Deflationary tendencies remain more entrenched than the central bank admits.
• China: Real GDP (Wed) growth is generally expected to hold steady at 6.7% y/y, while retail spending should continue to outpace industrial output.
• Other central banks: Rate-setting meetings will occur in Hungary (Tu), Russia (Fr), and Israel (Th), no changes expected at any.

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