According to Societe Generale’s Global Quantitative Research team, there’s more to an economic recovery than the beginning of a rate hike cycle, and there is a big problem with a strong dollar.
In SG’s November 19th Quant Quickie, Andrew Lapthorne and team highlight that a rate hike by the U.S. Fed does not tame a strong dollar or improve weakening U.S. corporate profit numbers.
Lapthorne et al. note that the Fed “…rate rise is flagged as confirming US economic leadership, we continue to be very concerned about US profits. For over a year now excuse after excuse has been rolled out as to why US profits are not actually as weak as the headline numbers imply, but the reality is the US profits and revenues are declining and the strong US dollar is a large part of the problem.”
Strong dollar leading to U.S. industrial profit recession in 2016
One thing to keep in mind is that changes in U.S. import prices front run profitability by around a year or so, and therefore as the SG analysts point out, “without a reversal in the fortunes in the US dollar, a US industrial profit recession looks baked in the cake for 2016.”
This, of course, begs the question of how much will the U.S. central bank be willing to “import’ global deflation (via the strength in the dollar) and in effect let other countries steal its sales?
Lapthorne and colleagues also note that U.S. corporate profits are falling even including energy. Of note, reported income is decreasing in the energy sector, but is also dropping in a variety of other sectors. Moreover, sectors that do not yet have negative EPS growth are only showing low single digit growth.
In addition to historical numbers coming in below most expectations, 2016 forecasts have also been slashed notably over the last 12 months. Not surprisingly, the largest downgrades have been seen in the Energy and Industrial Metals & Mining sectors. That said, beyond the known trouble spot sectors, projections for 2016 have been reduced across the board. The SG team does point to a couple of exceptions such as Retail and Health Care, but clearly 2016 is shaping up to be a year of slowing profit even if you throw out the energy sector.
They go on to hammer on the theme of the ills of a strong dollar paired with competitive devaluations elsewhere across the globe continuing to weaken U.S. profitability. Economic statistics already show the downward pressure on U.S. import prices, initially courtesy of Japan, and now the Eurozone and soon the Chinese.
Lapthorne et al. explain the strong dollar dynamic: “Weak US import prices are a killer of US industrial profitability as volumes simply drop off a cliff if you are priced out of a global market and become uncompetitive at home; there is a clear correlation between the relative performance of industrial versus consumer services and US import prices.”