Three Factors Behind The Stock Market’s Resilience

Apple has just announced its first revenue drop in 13 years.1

Goldman Sachs announced its profits fell 60% in a single quarter.2

Microsoft reported a 25% plunge in earnings.3

Welcome to the first quarter’s earnings season.

As of this writing, 207 members of the S&P 500 index have reported results. So far, total earnings have dropped 5.4%, while revenues have dropped 1.6%.4

More importantly, this will become the fourth quarterly earnings decline in a row, and the worst since 2009. We warned about this “earnings recession” last November in our Daily Pfennig® newsletter entitled, How Long Will the “Earnings Recession” Last?

We wrote, “The U.S. economy is technically not in a recession, but the stock market tells a different story. Stocks are on the verge of a recession – an earnings recession.” With such bad earnings, you’d think the stock market would be down a lot this year. But, so far, the S&P 500 index is up 1%. How is that possible?

Well, there are three forces behind the stock market’s resilience: 1) the recent recovery in oil, 2) a big drop in the U.S. dollar, and 3) share buybacks.

Let’s tackle each one separately.

How The Recent Oil Recovery Is Improving Sentiment
Just a month ago, the market was expecting earnings would fall 9.8% this quarter.5 So far, earnings have only dropped 5.7%.6 And, expectations have improved recently, in part because of a big change in the trend of oil prices.

You see, the crash in the price of oil from $100 to $27 a barrel delivered a huge blow to companies operating in the energy sector. In the last quarter of 2015, for example, earnings in the sector dropped 74% year over year.7

In other words, the energy sector accounted for most of the earnings drop in the last quarter of 2015. But, crude oil has rallied from $27 to $46 a barrel in the last two months. If prices stabilize at these levels, companies in this bruised and battered sector may get a break in the coming months, helping earnings recover later in the year.

Another new trend that could be helping stocks is the weak dollar.

Dollar Weakness Could Boost Future Earnings
In our November article, we also wrote, “If the dollar continues to appreciate, we could see a further decline in earnings in the coming quarters.” Well, since we published that article, the U.S. dollar index has actually dropped from 100 to 93, as you can see in the chart below.

Chart courtesy of StockCharts.com.

The strong dollar during 2015 caused the U.S. dollar value of overseas profits to fall. It was a big reason behind the earnings weakness. But, now that the dollar has dropped about 7%, it could provide some relief to earnings in the coming quarters.

The rally in crude oil and the recent drop in the U.S. dollar explain, in part, why earnings expectations have improved recently. But, there’s another factor that explains why the stock market hasn’t dropped much, despite the “earnings recession.”

A Big Factor That’s Keeping The Stock Market From Selling Off
There’s something going on behind the scenes that’s providing support to the stock market. I’m talking about stock buybacks, also known as corporate share repurchases.

This happens when companies purchase their own shares and “retire” them, reducing the number of outstanding shares in the market. This reduction in the supply of shares can make the outstanding shares more valuable.

Warren Buffett explained this phenomenon in his 1999 letter to Berkshire Hathaway shareholders stating, “Repurchases are all the rage, but are all too often made for an unstated and, in our view, ignoble reason: to pump or support the stock price.”8

Shares repurchases have been growing every year since 2012, as you can see in the chart below from the S&P Dow Jones Indices. This has played a role in the ongoing bull market in stocks.

Stock Buybacks ($Billions) 2009-2016

Source: S&P Dow Jones Indices

 

Keep an eye on those three things. If the dollar continues to weaken, oil stabilizes and companies continue to repurchase shares, the earnings recession might come to an end, helping push the stock market even higher.

On the other hand, if the trend of a strong dollar and weak oil resumes, the earnings recession could go on for a little longer. Keep a close eye on these things in the coming months.

Until the next Daily Pfennig® edition…

Sincerely,
Chris Gaffney, CFA
President
EverBank World Markets, a division of EverBank
1.855.813.8484
everbank.com