As we look back on the first quarter of 2016, for investors it is always worth looking back and asking the question: how did we get here? Aidan Donnelly reports.
Then 2016 shows up and in the first few weeks of the year the bottom drops out of markets – European equity markets had their worst first week of the year in history – and all fears were magnified. Those who talked of a recession were not immediately dismissed to the fringes, and as a result their calls become voracious.
To be fair, the mood music wasn’t helped by headlines of plunging oil prices, or Chinese devaluations, or even escalating tensions between Saudi Arabia and Iran.s we exited 2015, the prevailing narrative in most of the market outlook publications from global investment banks was that slow economic growth would remain but “sure we’ve had that for a while so the markets are used to it and all will be fine”.
Anyone buying … anyone buying?
Traditionally, large institutional investors enter the year with cash in their funds and a willingness to buy – this leads to the so-called January effect of positive markets.
This year was no different than previous years in terms of having that cash. But with markets heading lower from the get go, the desire to step in and buy, buy, buy was quelled pretty quickly, and sitting on the sidelines looked like it was indeed a very good place to be.
As January neared a close and investors cowered in fear of another 11 months of torture, a white knight in the form of European Central Bank (ECB) president Mario Draghi rode to our rescue with a near ‘deja-vu’ performance, stating that the bank stood ready to take action to assuage the concerns of investors.
He noted that “the credibility of the ECB would be harmed if they weren’t ready to revise the monetary-policy stance”, while also adamantly stating that the ECB has the “power, the willingness, the determination to act, and the fact that there are no limits to our action” – ooh rah! indeed.
A BRIEF RESPITE
Alas, whatever semblance of positivity that Draghi had created proved short-lived as a steady stream of disappointing quarterly results from some of the bellwether companies in the US and Europe, coupled with less-than-rosy pictures for the year to come, chipped away at confidence and saw most markets resume their downward trajectory.
And then we bottomed. February proved to be very much a month of two halves with a strong rebound in equities and oil in the back half. That rebound was not fuelled by a large asset switch, however, as the safe havens of government bonds did not in fact see a marked sell-off as equities rallied.
THE DARKEST HOUR
And what was the reason for the rebound? Some may say it is down to the celebrated groundhog, Punxsutawney Phil, who emerged from his hut and did not see a shadow, therefore signalling an early start to spring for the inhabitants of Pennsylvania and perhaps calling an end to the ‘winter of discontent’ in global markets.
Others will point to Jamie Dimon, CEO of JP Morgan, as he forked out $26.6m of his own money to buy shares in his own bank. Interestingly, a day later he had already made over $2m in profit (not bad, sir).
The reality is that – as the slogan in Bill Clinton’s presidential campaign famously put it – “It’s the economy, stupid!” Although the dates do not exactly coincide, it is worth noting that the run of disappointing US economic data troughed in early February and improved ever since.
As investors cowered in fear of another 11 months of torture, a white knight in the form of ECB president Mario Draghi rode to our rescue
Conciliatory noises from the oil market and an announced freeze in oil production rates from the members of OPEC certainly helped the air of positivity, but the lack of any further bad news was in fact the biggest boon to sentiment.
This helped risk assets in general, and the US in particular. European data continued to surprise to the downside, so although markets in general stabilised, Europe seemed to lose momentum – not helped by the fact that the banking industry was under pressure with a risk that threatened to spill over into the wider economy.
Just as well Draghi was on hand to step in again. After their March meeting, the ECB announced that it would further reduce the deposit rate into negative territory, as well as raising the asset-buying programme by €20bn to €80bn per month, and expanding the assets covered to include non-financial corporate debt – though the euphoria was short lived.
THE PROPHETS OF PROFITS
While it would be easy to just put the volatility in markets down to swings in investor sentiment, the reality is that fundamentals have also deteriorated since 2016 began. Economic growth rates for the major regions of the world have been reduced, but for stock markets the key concern has been a change in the outlook for company profitability.
During the first quarter of 2016, market analysts lowered earnings estimates for companies in the S&P 500. The Q1 profit estimate dropped over 8% during this period, making it the largest decline in forecasts since Q1 2009. But it wasn’t only the analysts who were reducing forecasts. In addition, a higher percentage of S&P 500 companies lowered the bar for earnings for Q1 2016.
Of the over 115 companies that have issued guidance for the first quarter, nearly 80% have been on the negative. As a result of these downward revisions, we are now seeing an estimated high-single-digit year-over-year decline in profits for Q1 2016, which is below the expected earnings growth of 0.3% at the start of the year.
What is more troubling for the investors is the fact that seven of the ten sectors are projected to report a year-over-year decline in earnings, led by the energy and materials sectors. The three sectors that are predicted to grow are led by the telecom services and consumer discretionary sectors.
BOTTOM LINE, SALES DECLINE
It is not just at the profit line that we are seeing changes. As a result of downward revisions to sales estimates, the estimated sales decline for Q1 2016 is -0.6%, which is below the estimated year-over-year sales growth rate of 2.6% at the start of the quarter.
Five sectors are projected to report year-over-year growth in revenues, led by the telecom services and healthcare sectors. Five sectors are predicted to report a year-over-year decline in revenues, led by the energy and materials sectors.
This has not just been a phenomenon in the US, and the upshot – or downshot as is the case – is that we have seen forecasted growth rates of global company profits halve since the year began. But barring any new global crises in the coming months, the outlook for profits should now stabilise – and as central bankers, particularly in Europe and Japan, stand ready to use any and all forms of monetary policy to foster growth, maybe Mr Market can just ‘chillax’. Alas, history would say otherwise!
Aidan Donnelly is head of Equities at Davy Private Clients. Views expressed in this article reflect the personal views of the author and not necessarily those of Davy or Business & Finance. Follow him on Twitter @aidandonnelly1.