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 S&P 500 earnings are on track to close their first reporting season
of negative growth since the Great Recession and estimates call for
sub-zero growth in the current quarter as well.
Even if the trend reverses next year, as expected, a Fed rate hike
in December could mark an unprecedented conflict between a
tightening cycle starting at the same time as earnings fall into
recession.
"We can't think of any instances when the Fed was hiking during an
(earnings) recession," said Joseph Zidle, portfolio strategist at
Richard Bernstein Advisors in New York.
"In the last six months one can point at a lot of different things.
But if you think about fundamentals, falling corporate profits and
the threat of rising rates" are behind the market stalling, Zidle
said.
With more than 90 percent of S&P 500 components having reported, S&P
500 earnings are down 0.9 percent in the third quarter. Absent
surprisingly high numbers from the companies left to report, it will
be the first negative growth quarter since the third quarter of
2009.
Fourth-quarter estimates are for a 2.4-percent earnings contraction,
according to Thomson Reuters IBES data; that would set up the two
quarters of declining earnings, required for a bona fide 'earnings
recession.'
That already occurred in the second and third quarters, according to
FactSet Research Systems, which calculates its quarterly results
slightly differently than does Thomson Reuters.
Furthermore, the decline in revenue has been steeper than that in
earnings, a bad sign for investors who like to put money into
companies that are growing sales and not just cutting costs or
buying back their own shares. Last quarter's sales are seen falling
4.3 percent and estimates for the current quarter are for a
2.7-percent decline.
It is hard to argue that those numbers correspond to an economy that
is on the brink of becoming too hot and in need for monetary policy
tightening.
The bulk of the S&P 500's earnings declines come from the energy and
materials sectors as commodity prices have tumbled to multi-year
lows.
The Fed, then, could be looking at the earnings decline as it does
low inflation: a problem that will take care of itself once the
declines fall out of the comparisons.
But if the Fed does decide to raise rates despite the gloomy
earnings, that could hurt investors who may get whipsawed by the
diverging cycles in the market and the economy.
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Conventional wisdom calls for a defensive position - buying
healthcare, staples and telecoms - when corporate profits are
falling, and aggressively buying cyclicals like energy and materials
at the start of a tightening cycle. Both are happening at the same
time.
"Rising interest rates are always a negative for stocks, period,"
said RBA's Zidle. "In most (tightening) cycles, corporate profits
are booming so much that the rise in profits is more than offsetting
the drag of interest rates."
FED PREPPING MARKETS
The Fed maintains its mantra of being data dependent when it comes
to tightening monetary policy, and though it has strongly hinted of
a December move, it also has acknowledged that it watches stock
prices.
Investors are reacting accordingly: Last week the S&P 500 came
within 1 percent of its record high set in May, but Friday it was on
track to close its worst week in two months.
"Since 2013 every time the Fed signals a rate hike (the stock
market) throws a tantrum, and that’s a little bit of what we’re
seeing now," said Michael Arone, chief investment strategist at
State Street Global Advisors' U.S. Intermediary Business in Boston.
"Over the last couple years, every time this has happened the Fed
has decided not to raise rates so we shall see if that cycle is
broken in December."
(Reporting by Rodrigo Campos; editing by Linda Stern and Nick
Zieminski)
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