The following commentary was originally sent to Trifecta Stocks subscribers on Feb. 9, 2016, at 2:10 p.m. ET.
If we look at the charts for the major market indices over the last few weeks, you would think we are riding a world-class roller-coaster filled with sharp moves lower, then higher before an eye-opening and white-knuckling fall, only to recover in the nick of time. Even a seasoned roller-coaster rider might be tempted to reach for the vomit bag. I'm exaggerating a bit, but only by a little as 2016 started out volatile and continues to be turbulent, as we are seeing again this week.
Amid the ups and downs, the question many investors want answered is, "What's going on?"
As we like to say in the investing world, there is no silver bullet that provides all the answers for picking a particular stock, and the same holds true in answering that question. There are several factors driving the market and movement in particular sectors, including the down-and-up movement in oil prices, the on-again "Will the Fed raise rates or not?" chatter that led to market volatility in 2015, monetary stimulus actions outside the U.S. and currency moves that will keep foreign exchange headwinds in place well into 2016. That's just a short list.
If we pull on each of those threads, we find ourselves coming back to one central theme, and that is the resetting of growth expectations.
Over the last several months, we've received more data than we can rattle off from Markit Economics, the Institute for Supply Management, the Federal Reserve and the Census Bureau, all of which point to a far slower economy than was expected as we entered 4Q 2015. The initial GDP print for that quarter was 0.7%, compared to the expectation for 2% in September, and in recent days economists from the likes of Deutsche Bank and other investment banks have started to trim back GDP expectations for the first half of 2016 and the full year. Deutsch Bank in particular cut its 1Q 2016 GDP forecast to 0.5% from 1.5% and revised its view on 2Q 2016 GDP to 1.0% from 2.2% this week. Given the tone of the domestic manufacturing economy and the slower growth being reported in the domestic services economy, these GDP revisions are far from unexpected.
You've probably noticed a growing number of companies that have been delivering weaker-than-expected guidance relative to Wall Street expectations. Our take on that is that, much like those GDP forecasts, corporate outlooks are catching up to the economic picture that's been painted in all that data of the last several months.
Aggregating those weaker-than-expected outlooks has led to a significant rethink and recalculation when it comes to earnings expectations for the S&P 500, the barometer of the market and the yardstick by which P/E and earnings expectation growth rates are judged. Exiting last week, expectations for the S&P 500 earnings in 2016 continued to tick down and now sit at $122.75 per share, a reduction from $123.32 per share the week before and substantially lower than $130.55 per share in October, per data from FactSet. Year over year, the latest revision equates to just 4% growth in collected earnings from the S&P 500 group of companies this year -- less than half what what expected back in October.
As grim as that may sound, there are others who are dialing back their growth expectations even further. Noted economist Ed Yardeni, president of Yardeni Research, has cut his 2016 expectations to $122 per share for the S&P 500, up 3%, and also recast his 2017 expectations to $128 per share, which still reflects 5% growth year over year.
The bottom line is that valuation multiple assumptions are being rethought as growth expectations move lower.
Digging into the 2016 S&P 500 earnings revisions we've received thus far, analysts are again calling for pronounced earnings acceleration in the back half of 2016 with the third quarter up 5.5% and 4Q up 10.7% following declines in the first half of the year. When we see such significant reversals, particularly several quarters out, we have to wonder about the underlying assumptions and whether or not those making them are listening to the data or if they are closing their eyes and wishing for the best. Heading into this week, we still had another third of the S&P 500 companies yet to report results, and given the glide path of the economy, we continue to see more downside than upside with S&P 500 earnings expectations in the near term.
The combination of all of this has led to a very nervous stock market that has adopted a "shoot first and ask questions later" mentality. It can be very frustrating and confusing, especially when a company delivers a solid quarter and favorable outlook, but the shares continue to come under pressure. While a number of large-cap stocks have been hit, like Amazon (AMZN) shares that are down just over 28% since late December, small- and mid-cap growth has taken it on the chin rather hard. Year to date, the iShares Russell 2000 Growth Index ETF (IWO) is down more than 18% compared to down 9.75% for the S&P 500.
Seeing the coming storm, we exited a number of positions in the Growth Seeker and Trifecta Stocks portfolios in early January, boosting our cash positon significantly in the process, which has been a comfortable port in the storm and has allowed the portfolios to outperform the market on a relative basis.
Amid the current maelstrom, we are digging into potential portfolio candidates as well as monitoring incoming economic data so we can continue to get a read on the vector and velocity of the economy. We're also listening to many earnings conference calls, cross-referencing management commentaries, outlooks and data points (capital spending, the competitive and regulatory landscapes, for example). Dialing in and listening to Boeing's (BA) earnings call and cross-referencing it with systems supplier B/E Aerospace's (BEAV) and others' helps paint a more telling picture of the aerospace market. The same can be said with Apple (AAPL) and suppliers like Skyworks Solutions (SWKS), Qorvo (QRVO), NXP Semiconductors (NXPI) and Avago Technologies (AVGO). We're also watching new technology and other developments that are coming into the mainstream, like voice interfaces such as Apple's Siri and Amazon's Alexa that power its new Echo product, and drilling into potential candidates. (Amazon and B/E Aerospace are part of TheStreet's Growth Seeker portfolio. Apple is part of the Action Alerts PLUS portfolio.)
The goal of all that activity is to build our shopping list for when the market does indeed settle down. We'll continue to favor companies with strong thematic tailwinds that are poised to grow profits faster than sales and deliver earnings growth well above the S&P 500 in the coming quarters. A solid balance sheet is always a plus.
Even after all the volatility we've experienced thus far in 2016, the probability is rather high that the coast is far from clear. As earnings season eventually winds down in a few weeks, we'll be eyeing the next round of economic data to see if we are on firmer footing or if economic growth and earnings expectations will need to be revised further. Based on the findings, we'll start to put cash in the portfolios to work.
