Headwinds To US Earnings Growth Abate by Joseph G. Paul
The US stock market has gone nowhere for the past 15 months, with plenty of volatility along the way, as the Display below shows. To a large extent, the flat market reflects flat earnings, which peaked at the end of 2014 and have declined modestly since then. But we think the headwinds to US earnings growth are abating.
Investors have been reluctant to push the market higher without earnings growth. Fortunately, two headwinds—falling oil prices and the strong dollar—are losing force. Oil prices have recovered from recent lows and the US dollar has stabilized, although Brexit fears created wobbles in both the price of oil and the dollar. Better year-over-year comparisons for both should reveal growth in earnings, particularly for the energy and tech sectors, the next Display shows.
The more than 75% plunge in oil prices from June 2014 through February 2016,depressed earnings for energy companies: The operating cash flow of the 21 largest oil-focused E&P companies fell 50% in 2015. But the industry has cut costs and scaled-back development plans in an effort to ride out the swoon in oil prices. With oil and gas prices recovering, year-on-year earnings comparisons in the energy sector could turn from a headwind to a tailwind.
Meanwhile, the rising US dollar depressed earnings for many US multinationals by reducing the dollar value of earnings generated in other countries overseas, and by making US goods unaffordable to many non-US buyers. From the end of September 2014 through early January 2016, the US dollar rose nearly 20% against a trade-weighted basket of currencies. But the US dollar has declined about 2.5% year to date against a trade-weighted basket of currencies. If the currency stabilizes around current levels, it too, could provide a modest tailwind to corporate earnings.
The technology sector would be one of the principal beneficiaries of a stable dollar: US technology firms generate nearly 60% of their sales internationally. Gartner Research estimates that the strong US dollar reduced global IT spending by $217 billion dollars in 2015—more than the most recent financial crisis did. In spite of this headwind, the US technology sector delivered slightly positive revenue growth last year, but margins contracted. Without the year-over-year drag from a stronger dollar, both revenues and margins stand a chance of recovery.
Over the next five to 10 years, we expect US stocks to return nearly 6% annually, with roughly nearly 4% coming from earnings growth, about 2% from dividends, and no meaningful change in valuations. We think that with flat to rising energy prices and a modestly weaker dollar, stocks can get back into gear, albeit a low one.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.
