Don’t Slump in October!

Only the best baseball teams are still playing in October, and if anyone “slumps” now, there’s a good chance their season ends short of a World Series championship. The current economic expansion resembles baseball in some ways. There’s not much excitement most of the time, but when the action comes, you do not want to miss it!

At seven plus years, it is already the fourth longest expansion on record. Some pundits claim that alone is a reason to avoid investing. However, as long as we do not get the proverbial “three strikes against us,” the expansion can keep growing.

Unfortunately, the heart of the order of economic indicators is in a slump. It is the quarterly earnings season when companies report their revenues and profits to the public, and both began a decline last year. As usual, the revenues fell into negative territory about two quarters before earnings inevitably followed suit.

Despite the earnings slump, both our economy and our stock market are slowly, painfully slowly, growing in the most anemic expansion since the Second World War. US Gross Domestic Product averaged just 1.6% growth from January 2015 through this June, while the S&P 500 Index gained just 5%i.

watchThe stock market can continue growing, but not consistently in my opinion, without corporate earnings expansion.

So, what’s causing the slump in earnings and can it be fixed?

The energy sector, which represented over 10% of the S&P 500 index before its collapseii, took the entire index into negative growth due to the size of its losses last year. The rout continued into January 2016 when oil prices fell below $30 per barrel,iii and the sector dropped to just 6.5% of the index by the end of 2015.iv

However, global energy demands are expected to continue growing at about 1.4% per year, and according to the U.S. Energy Information Administration, liquid fuels (oil) are likely to continue meeting the largest share of these demands. The energy companies remaining after the shakeout will be comparing their current earnings to the terrible figures from the slump, and consequently, the numbers should get much stronger, powering the index’ earnings per share numbers and therefore stock prices.

Furthermore, the recent apparent stabilization of oil prices in the $40 to $50 range is good for consumers. According to energy.gov, gasoline prices averaged above $3.50 per gallon from 2011 to 2013 but dropped to just $2.45 in 2015. For a driver buying 30 gallons a week, that leaves $28.50 available for other spending. Annually, that is nearly $1,500 of discretionary money available.

One way they are spending it is by driving more. In 2015, Americans drove more than 3 Trillion miles and were expected to increase it another 3.6% in 2016.v Moreover, we keep buying cars; light vehicle sales, at 16.9 million units, are well above the 20-year average of 15.5, supporting one of our most important industries.

However, housing starts remain about 13% below their 20-year average levels, demonstrating challenges for another core industry, construction. But prices for existing homes are within 1% of their peak reached eleven years ago, and with prices this strong, new home construction is likely to continue building momentum, especially as Millennials start creating new households.

The economy survived the earnings slump this time around the batting order, but now faces several unfamiliar new pitches along with the global economy: a rise in nationalistic protectionist sentiment, aging and declining workforces, and the threat of terrorism. Inside the clubhouse of our domestic economy, companies face the most oppressive tax and regulatory environment in the developed free world.

Contact us to discuss our ideas for building a portfolio designed for these uncertain times which can help you pursue your individual financial and life goals.

 

i Sources: Bureau of Economic Analysis and Yahoo!Finance.
ii JPMorgan Guide to the Markets 2014Q1
iii http://www.macrotrends.net/1369/crude-oil-price-history-chart
iv JPMorgan Guide to the Markets 2016Q1
v http://www.afdc.energy.gov/data/10315

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted.

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