According to Factset, the bulk of S&P 500 companies have reported earnings. To this date, the blended earnings decline is about 1%.
The last quarterly earnings decline noted by the S&P 500 companies was Q3, 2012. As then, bears consider this decline to be the start of a new recessionary period and seek to call a top to the 6 year bull period for equities. In my view, this period merely represents a transitional time in the current cycle. The diminished and soon-to-be-absent profitability of capital intensive industries reliant upon oil drilling, exploration, extraction and production of minerals & energy had fully offset superior growth rates enjoyed by non-cyclical industries in the recently ended fiscal quarter.
A recent currency adjustment in the yuan of China was a surprise and represents a useful salvo to stave off that country’s slower economic growth. However, little in the global economy occurs in a vacuum. More nations will logically seek to devalue their currency, or widen their bands as a countermeasure. Vietnam, as one example, immediately responded to the Chinese initiative by widening its own currency band.
Businesses that supply goods and services to the cyclical sectors appear to have at least one more quarter of declining earnings ahead. A continued depression in energy prices does place considerably greater purchasing power in the hands of consumers and also helps balance budgets of countries with energy import deficits.
Recently the United States has sought to draw Iran out of the economic hinterlands and into the global consumer economy through a proposed nuclear agreement. While policy wonks debate the potential geopolitical consequences of such an embrace, one clear global economic benefit seems to have been completely overlooked; a sanction free Iran is capable of increasing oil exports quite sharply and almost immediately. Unconstrained by sanctions, increased Iranian exports of very sweet light crude may cap oil prices and have the potential to further reduce the cost of crude to consumers, over the near to medium term. Low energy prices provide meaningful economic multipliers for key economies and should support continued overall growth for global equity markets.
A secondary, equally important, geopolitical benefit to low crude and natural gas prices is taking hold. The longer fuel prices remain subdued, the weaker becomes the economy of Russia. When Russia’s economy becomes enfeebled by the lack of foreign hard currency, the more likely it is that Putin’s policy of global belligerence will abate. Political bluster, bombastic PR and inflated national pride can certainly support a false sense of self for a time; neither bombast, nor pride, represent actual currencies capable of purchasing imported bread.
Unless a nation is able to confiscate the wealth of another nation during military conquest and use the loot to fund further incursions, capital is always expended, as opposed to being invested, in the projection of military might against other nations. Russia’s manufacturing-light, consumer products-absent and service export-negligible economy exists solely on strong energy, materials and mineral pricing. Energy windfalls enable Putin to fund his revanchist foreign aggressions, assemble fast attack military bases to bully spurious claims over much of the northern territories of Alaska, Canada & Europe while simultaneously fronting massive import deficits incurred by the local populace. Windfall profits for oil and gas ended some time ago; something will eventually have to give.
The result of Iranian inclusion in the global community might be hard for some to stomach. Should a byproduct be a simultaneous implosion of the Russian economy, as a consequence, that would be seen by many in the west as a potentially greater win. Iran, through proxy funding, is largely a regional irritant for majority-Sunni Arab nations that choose not to defend themselves. Russia, in contrast, represents a far more urgent and existential threat to Europe, NATO and North America.
Economic matters tend to win out over geopolitical issues in equity markets longer term. However, to increase one’s equity exposure to Europe, while seemingly sound, prima facie, based upon the forecast of a diminished Russia; that may still turn out badly. Invasions and proxy conquests of impoverished and bankrupt nations such as the Ukraine don’t generate much in the way of hard currency, confiscatable spoils or valuable factories. When push comes to shove, a fiscally embattled Putin might opt to attempt the acquisition of more developed western European territory.
The investment policy of this author is to continually minimize direct portfolio exposure to commodity based investments or to businesses that lack pricing power. Such a policy appears meritorious in the prevailing investment environment. The quarter to come should continue to demonstrate a clear divergence between commodity based & heavy industrial companies, that appear to be hobbled by flat global growth, vs. my choice of owning monopolistic, consumer driven, businesses with exceptionally reliable, and potentially accelerating, earnings growth.
Dividend income will be used to add to existing positions in the quarters to come. Based upon the recent strong outperformance of the global large cap portfolio against indexes and all active peers in the sample, it appears that the account’s holdings still remain in the economic sweet spot.