As you may know, we are in the midst of another quarterly earnings season. The onslaught of news about the health of corporate America is a welcome relief to recent news cycles focused on trade/tariffs, impeachment and various indiscretions in Washington. The S&P 500 reached a new all-time high yesterday and while some may want to launch fireworks, let’s put these lofty levels of the market into a broader context.
While the S&P did close at an all-time high, if you look back at the market over the past 6 months, you will see that we’ve gone almost nowhere. The chart below shows the S&P 500 over the past 18 months (the highlighted part shows the past 6). Notice the highs we are hitting now are only slightly higher than the highs from September, roughly equal to the highs in July, and only a few percentage points higher than May.
So why are we just treading water? Let’s think about corporate earnings. Third quarter earnings released thus far show a decline in earnings compared to the 3rd quarter of 2018 – down 3.7% for S&P 500 companies that have already reported. So why is the market not down as well? It could be that the market is looking ahead, expecting that this quarter may be a trough in earnings and that we may see renewed growth ahead.
The market is always comparing this year to the past and as you remember 4th quarter of last year was rough for both earnings and the market. That rough patch makes it easier to show year-over-year growth. If the market is expecting renewed earnings growth in 4th quarter 2019 and then into 2020, moving back to all-time highs is reasonable. And if we do begin to see evidence of such, it would also be reasonable to expect the market to move even higher. We’ll see.
Digging even deeper into the data uncovers two fairly stark dichotomies. Break apart earnings from companies where most revenue comes from inside the US versus internationally and you see a huge difference. In the chart below, the light blue bar (far left) is showing earnings for S&P 500 companies with more than half of their revenue coming from within the U.S; the green bar (far right) shows earnings growth for companies with less than half coming from within the U.S.; the dark blue bar is for all S&P 500 companies.
Companies with more revenue coming from international sources show a much greater decline in earnings (-9.1%) compared with companies with most of their revenue coming from inside the US (-0.8%). This is likely the result of two issues – the ongoing trade disputes pushing down sales growth, but also the strength of the dollar compared with other currencies. Remember that if you are Proctor and Gamble selling Crest toothpaste in Europe, you sell it in Euros and then have to convert those sales to US Dollars. A strong dollar creates headwinds for big international companies.
But these two issues (trade and dollar strength) may have reached their peaks. Trade talks seem to be going well and most pundits predict a Phase 1 deal with China in mid-November. And while the dollar may not decline appreciably in the coming months, the upward pressure is being reduced as a result of the Federal Reserve’s recent interest rate cuts. An expected cut later this week and another one in December will help.
Digging even deeper into the data show certain sectors of the market being impacted more than others as a result of their revenue source. Each bar below is divided into two colors; the blue represents the percent of revenue coming from within the U.S and the green represents the percent coming from an international source. Let’s take a look at each side of the chart.
The bar on the far left is showing the utility sector of the market. Not surprisingly, the vast majority (97%) of the revenue of utility companies (Duke Power or American Water Works) comes from within the U.S. The bar on the far right is the information technology sector of the market. For companies like Apple and Google, a tremendous amount of their revenue comes from an international source. Across all information technology companies, only 43% of their revenues comes from U.S. sources – about half that of utilities.
Given these data and our earlier discussion, what would you expect about relative performance across these sectors of the market? Sure, utilities and real estate (the two bars at the left) should be outperforming information technology and materials (the two bars at the right). And that is exactly what we have seen over much of 2019.
But that may be changing. With easier to beat year-over-year comparisons coming, coupled with a peak in headwinds from trade and dollar strength, we may see a pick-up in earnings growth from companies with an international exposure. And with that, we may see a pick-up in the returns of some of the laggards in portfolios. It’s certainly something we are watching!
If you have questions or would like to chat about this or anything else, please let me know. Here’s to a Halloween treat in the coming weeks.
