Weekly Trends

Ryan Lewenza, CFA, CMT, Private Client Strategist

April 8, 2016

Earnings Trough?

Equity Market YTD Returns (%)

S&P/TSX Comp

US corporate profits have been weak in recent quarters, both from a quality
perspective (see Chart of the Week) and from a trend perspective. For Q1/16,
S&P 500 Index (S&P 500) earnings are projected to decline 8.7% Y/Y, which
would mark the fourth consecutive quarter of negative earnings growth.

S&P/TSX Small Cap

We believe US corporate earnings are close to an inflection point and could start
to improve in the following quarters. Currently, consensus estimates for the S&P
500 point to a trough in earnings in Q1/16, with earnings growth turning positive
in H2/16.
Our expectation for stronger earnings in H2/16 is predicated on the following
factors: 1) stronger economic growth; 2) higher oil prices; and 3) less of a
headwind from the US dollar which we expect to trade in a range for the
remainder of the year.

9.2

S&P 500

We believe there are a few key trends that are weighing on corporate profits.
They include: 1) lackluster US and global economic growth; 2) contracting net
income margins; 3) the stronger US dollar; and 4) the steep drop in oil prices
which has weighed on energy sector earnings.
With four consecutive quarters of negative earnings growth we are clearly in an
earnings recession, and with the S&P 500 trading back near its all-time highs, the
market is vulnerable to weakness should this not reverse in the coming quarters.

3.0

0.7

Russell 2000

-2.8

MSCI World

-2.5

MSCI Europe -10.3

MSCI EAFE

-6.3

MSCI EM

1.9
-15

Canadian Sectors

Earnings Quality Has Deteriorated With The Gap Between

-5

Weight

10

Recommendation

6.7

Underweight

Consumer Staples

4.7

Market weight

Energy

18.3

Market weight

Financials

38.1

Market weight

Health Care

3.0

Underweight

Industrials

8.0

Overweight

Technology

3.2

Overweight

Materials

9.5

Market weight

Communications

5.9

Overweight

Utilities

2.5

Underweight

Level

Reading

S&P/TSX Composite

13,397.8

50-DMA

13,030.8

Uptrend

200-DMA

13,456.6

Downtrend

48.7

Neutral

RSI (14-day)

Operating and Reported Earnings Widening

16,000
$120

15,500

Difference
S&P 500 12-Month Trailing Operating EPS
S&P 500 12-Month Trailing Reported EPS

$100

15,000
14,500
14,000

$80

13,500
13,000

$60

12,500
12,000

$40

11,500
11,000

$20

S&P/TSX
50-DMA
200-DMA

$0
'90

'92

'94

'96

'98

'00

'02

'04

'06

'08

'10

'12

'14

Source: Bloomberg, Raymond James Ltd.

Please read domestic and foreign disclosure/risk information beginning on page 4

Raymond James Ltd. 5300-40 King St W. | Toronto ON Canada M5H 3Y2.
2200-925 West Georgia Street | Vancouver BC Canada V6C 3L2.

15

Consumer Discretionary

Technical Considerations

Chart of the Week

-10

Source: Bloomberg, Raymond James Ltd.

Sectors are based on Bloomberg classifications

Weekly Trends

April 8, 2016 | Page 2 of 4

Earnings Trough?
Since the equity market bottom on February 11, the S&P 500 has rallied 239 points or
13%. Ideally, equity gains are driven by an improvement in fundamentals; however,
this has not been the case in this recent rally. Deconstructing the equity gains since
the February low shows that the gains have been driven by an expansion in equity
multiples (i.e., P/Es). P/Es are driven more by changes in short-term sentiment rather
than an improvement in corporate earnings, which is a better reflection of underlying
fundamentals. With the Q1/16 earnings season kicking off next week, we are focusing
this weeks publication on the outlook for US corporate earnings.
When analyzing US corporate profitability we tend to focus on two key areas
national income and products accounts (NIPA) and the S&P 500. NIPA is calculated by
the US Bureau of Economic Analysis and measures corporate profits earned by all US
corporations, and as such, provides a fuller picture of US corporate profitability. On
this broad measure things dont look so great, as corporate profits declined US$144
bln or 8% on a Q/Q basis in Q4/15 to US$1,639 bln. Based on this measure of US
corporate profits, profits peaked in Q2/15, and have been trending lower since.
S&P 500 profits have been similarly weak over the last year. Currently, analysts are
forecasting earnings to decline 8.3% Y/Y in Q1/16, which would mark the fourth
consecutive quarter of negative earnings growth. We believe there are a few key
trends that are weighing on corporate profits. They include:

Weak sales growth: It all starts with the top-line, which is driven by GDP
growth. With lackluster US and global economic growth, S&P 500 sales
growth has been negative for the last four consecutive quarters. For Q1/16,
analysts are forecasting sales to decline 1.2% Y/Y.

Rally From February Has Been

Driven By Expanding Multiples
16.0%
14.0%

Percent Change in S&P 500 P/E

Percent Change in S&P 500 EPS

12.0%
10.0%

8.0%
6.0%

4.0%
2.0%

0.0%
-2.0%
11-Feb 18-Feb 25-Feb 3-Mar 10-Mar 17-Mar 24-Mar 31-Mar

Source: Bloomberg, Raymond James Ltd.

Net margins: Contributing to the weakness in earnings are net income

margins, which according to Factset have declined from a peak of 10.75% in
Q3/14 to a forecasted 10.5% for Q1/16.

Strong USD: The US trade-weighted dollar is up over 20% since 2014. With
many S&P 500 companies generating a significant amount of sales globally,
the stronger dollar has weighed on results due to translation effects.

Oil prices: Finally, the steep drop in oil prices has weighed on energy sector
earnings, and in turn, S&P 500 earnings. If you exclude energy, S&P 500
earnings are projected to be -3.7% versus the 8.3% expected decline.

With four consecutive quarters of negative earnings growth, we are clearly in an

earnings recession, and with the S&P 500 trading back near its all-time highs, the
market is vulnerable to weakness should this not reverse in the coming quarters.
S&P 500 Quarterly EPS Growth
10%

9.2%

8.5%

$2,000
$1,800

6.6%

5.9%

5.4%
4.5%
3.7%

5%

Total US Corporate Earnings Have Rolled Over

11.4%

10.5%
9.4%

3.6%

5.1%

$1,600
$1,400

2.3%

0.6%

$1,200

0%

$1,000

-0.1%
-1.5%

$800

-1.8%

-5%

$600

-5.3%

S&P 500 Quarterly EPS Growth Y/Y

$400

2016/4C

2016/3C

$200

2016/2C

2016/1C

2015/3C

2015/2C

2015/1C

2014/4C

2014/3C

2014/2C

2014/1C

2013/4C

2013/3C

2013/2C

2013/1C

2012/4C

2012/3C

2012/2C

Source: Bloomberg, Raymond James Ltd.

2015/4C

-8.3%

-10%

$0

National Income After Tax Profits Excluding IVA & CCJ (in Bls)
National Income After Tax Profits Including IVA & CCJ (in Bls)
'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15

Weekly Trends

April 8, 2016 | Page 3 of 4

H2/16 Recovery
We believe US corporate earnings are close to an inflection point and could start to
improve in the following quarters. Currently, consensus estimates for the S&P 500
point to a trough in earnings in Q1/16, with earnings growth turning positive in
H2/16. Given our contrarian nature, we often prefer to go against consensus, but in
this particular case we believe the consensus may be correct. Our expectation for
stronger earnings in H2/16 is predicated on the following factors:

Stronger growth: While many analysts have been lowering their estimates
for corporate earnings since the start of the year, we have stuck with our
S&P 500 2016 forecast of US$123.36/share. Weve done this for two key
reasons. First, we havent even had one full quarter of earnings for 2016, so
its far too early to make adjustments, in our view. Second, there has been
no change in our economic growth expectations for this year. Job growth
remains very strong, US housing continues to improve, while consumer
spending remains healthy with retail sales up 3.1% Y/Y, US auto sales at
16.5 mln annualized and consumer confidence continuing to trend higher.
More recently, economic data has improved with key reports such as the
ISM Manufacturing Index showing a reacceleration of growth. As such,
economists see US real GDP growth increasing from 1.2% in Q1/16, to 2.4%
in H2/16. Based on our econometric sales model, this should translate into
4% sales growth for the S&P 500 in 2016.

US GDP Expected To Pick Up In H2/16

6.0
US GDP Growth Q/Q Annualized

4.6

5.0

4.3

3.0

3.0 2.7
1.9

2.0

2.1

1.9

0.5

2.3 2.4 2.4

2.0
1.4 1.2

1.1

1.0

Consensus
Forecast

3.9

3.8

4.0

0.6
0.1

0.0
-1.0

-0.9

-2.0

Q1/12 Q3/12 Q1/13 Q3/13 Q1/14 Q3/14 Q1/15 Q3/15 Q1/16F Q3/16F

Source: Bloomberg, Raymond James Ltd.

Oil price recovery: As discussed, energy sector earnings have significantly

weighed on overall S&P 500 earnings. In Q1/16 alone, energy sector
earnings are projected to decline 106% Y/Y, and represent 56% of the
expected 8.6% Y/Y decline in this quarter. With our expectations for higher
WTI oil prices in H2/16, this major drag should diminish and turn into a
tailwind later this year and into 2017.
US dollar: We believe the US dollar may have topped out in December, with
the US Dollar Index to trade in a range for the remainder of a year. If correct,
this significant headwind to US corporate earnings may begin to wane.

In summary, US corporate earnings have had to contend with a number of headwinds

in recent quarters, which we believe are set to reverse in the coming quarters. As
such, we believe the US earnings recession is nearing an end, with S&P 500 earnings
reaccelerating in the H2/16. We note that 12-month forward earnings expectations
for the S&P 500 have recently turned up, adding support to our reacceleration call in
H2/16.
S&P 500 Q1/16 Sector Earnings Growth Estimates

S&P 500 Forward Growth Estimates Have Turned Up

$127

Cons Disc

12.5%

Telecom

4.4%

Health Care

3.4%

Utilities
Industrials
Info Tech

-3.8%

$125

-4.5%

$124

-7.1%

S&P 500

-8.3%

Financials

-8.9%

Materials
Energy

$124
$123
$123

-20.6%
-105.8%

-125%

-105%

-85%

Source: Factset, Raymond James Ltd.

-65%

-45%

$126
$125

-2.2%

Cons Staples

-25%

S&P 500 12-Month Forward EPS Estimate

$126

-5%

15%

$122
Oct-15

Nov-15

Dec-15

Jan-16

Feb-16

Mar-16

Weekly Trends

April 8, 2016 | Page 4 of 4

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