The Margin For Error In The U.S. Equity Market Appears Historically Thin

Lower crude oil prices and dollar appreciation continue to degrade anticipated corporate profitability, exemplified by first- through third-quarter S&P 500 earnings growth that dipped into negative territory at the start of the final week in April. First-quarter consensus earnings growth expectations have subsequently improved to 2.2% at the start of May. Investor sentiment meanwhile continues looking past the lackluster 2015 earnings outlook, likely reflecting expectations for an  improving economic and earnings outlook over the balance of this year.

However, recent U.S. economic data have not overtly supported the optimists. The Conference Board’s Consumer Confidence Index declined unexpectedly in April to the lowest level seen this year, March new orders for durable goods--excluding transportation--registered a sixth consecutive monthly decline, and the April manufacturing PMI was disappointing at 51.5, unchanged from March. Investors must once again reconcile the generally opaque outlook for economic growth and corporate earnings with an equity market that remains resolute.

As the U.S. economy moves past first-quarter weakness (GDP growth +0.2%), Global Markets Intelligence Research is closely following consumer-centric economic indicators and consumer discretionary sector earnings for signs that ongoing investor optimism is warranted. With the consumer accounting for just over sixty percent of U.S. GDP, the future health of the core goods-and-services consumption-oriented economy should be the central concern of investors for the rest of the year, regardless of future swings of either crude oil prices or the U.S. dollar’s exchange rate value.

The outlook for S&P 500 consumer discretionary earnings growth is particularly noteworthy since first-quarter earnings are expected to be the low point from which a significant recovery should occur. Consumer discretionary earnings currently track (5/4/15) a respectable 6.2% growth rate and are then expected to improve to 7.9% in the second quarter, 15.0% in the third quarter, and 13.9% in the fourth-quarter of 2015 before peaking at 20.1% in first-quarter 2016. This optimistic outlook for consumer discretionary earnings could be among the key factors underpinning investor fortitude in this seemingly sub-ideal investing environment. Prospective positive news from the consumer discretionary sector could easily outweigh concerns relating to depressed oil prices and dollar strength, in our view.

S&P 500 Consumer Discretionary Earnings Growth

Investor optimism appears steadfast, even as recent soundings on the economy and overall S&P 500 corporate earnings might suggest otherwise. We suspect that investor patience may start to thin if conditions have not started to improve by the end of first-quarter earnings season. We remain reasonably confident that upcoming high-profile economic data, such as employment, retail sales, and anticipated S&P 500 earnings growth, will begin to portray the U.S economy more positively. However, we will also look for signs that there is more to recent disappointing data than this year’s severe winter weather, weak crude oil prices, and the dollar can rationally justify. As the S&P 500 index trades optimistically at approximately 17.5-times expected forward earnings, at a time when expected calendar-year 2015 earnings growth is essentially flat, the margin for investor judgement error could turn out to be historically thin, in our view.            

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