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Slowing Corporate Earnings May Mean End of The Bull Market

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Slowing Corporate Earnings May Mean End of The Bull Market

Wall StreetWith the bull stock market that began in March 2009 entering its seventh year, is the end of the bull market nearing? Slowing corporate earnings may mean end of the bull market, or at least a much more gradual and volatile ascent in stock market averages.   Ultimately, it is corporate earnings that drive the stock market higher or lower over time.

The first quarter of 2015 is expected to be the first earnings contraction since the Great Recession of 2008 / 2009, with corporate earnings in the United States expected to decline by 2.7 percent when Q1 2015 earnings are reported during the spring. While corporate earnings are expected to pick up as 2015 progresses, they will be the weakest annual earnings since 2009. Earnings are being hurt by two factors, the rising United States Dollar and falling oil prices. On top of that, the current bull market has the major headwind developing, as the Federal Reserve is expected to raise interest rates for the first time since 2006.

Slowing Corporate Earnings May Mean End of The Bull Market

Rising United States Dollar The slowdown in corporate earnings during 2015 is certainly a concern for stock market bulls that are invested in stocks expecting them to continue to rise during 2015 and beyond. The Standard and Poors 500 (S&P 500) index is trading at a Price to Earnings (P/E) multiple that is 17 times projected 2015 earnings. With the long-term Price to Earnings (P/E) multiple for the S&P 500 index around 15 times earnings, any slowdown in earnings growth during 2015 could cause the stock market to have trouble finding justifications to rally higher. If anything, the stock market may revert to the mean of 15 times earnings, which would result in an approximately 13% sell-off from current levels.

Time will tell what 2015 earnings actually turn out to be for the 500 companies in the Standard and Poors 500 (S&P 500) index, but here are some reasons to be concerned about corporate earnings and the continuation of the bull market during 2015. There are three primary concerns.

  • The rising United States Dollar is causing companies located in the United States that do business overseas to reduce their earnings estimates. When foreign profits are converted into United States Dollars, they are converted into less Dollars as the United States Dollar increases in value.   This trend, which has hit multi-national corporations that do business throughout the world quite hard, started showing up during the 4th Quarter 2014 earnings season. The trend is expected to continue well into 2015, as the strengthening United States Dollar shows no signs of letting up.
  • Falling oil prices might be good for the overall United States economy and certain sectors of the economy, such as the restaurant and entertainment sectors; however, drastically lower oil prices are having a big impact on the overall reported earnings for companies in the Standard and Poors 500 (S&P 500) index.   Companies in the oil and natural gas sector of the economy make up approximately 10% of the Standard and Poors 500 (S&P 500) index. These companies will report dramatically lower earnings during 2015, due to lower oil prices. This in turn will pull down overall Standard and Poors 500 (S&P 500) index earnings, making 2015 a tough year for earnings growth.
  • The Federal Reserve is expected to raise interest rates during 2015 for the first time since 2006. While the interest rate increases during 2015 are not expected to be large, they are going to cut into corporate profits, since companies have become accustomed to operating in a near zero interest rate environment. Companies will have to pay more for the capital that they need to run their businesses, which in turn will cut into their profit margins and reported earnings.

Will Slowing Corporate Earnings Mean The End of The Bull Market?

End of The Bull MarketThe question that ultimately needs to be answered is will slowing corporate earnings mean the end of the bull market? Since bull markets are fueled by rising corporate earnings, there are valid concerns that 2015 might mark the end of the current bull market, or at least a near-term top until the economic picture becomes clearer.   For the bull market to continue, the macro factors, such as the rising United States Dollar and falling oil prices, will have to stabilize and reverse course. Rising interest rates tend to put a short-term damper on bull market rallies, but their dampening effect is limited over the medium-term, as strong economic growth usually overrides rising interest rates.

Regardless of how much the earnings growth rate slows down in 2015, it appears likely that 2015 is going to be a much more volatile year for the stock market, and any gains are going to be hard fought and likely minimal compared to recent years. While it may not yet be time to throw in the towel and get ready for the next bear market sell-off, 2015 is a time when asset reallocation away from stocks and into other asset classes, such as cash and real estate might make sense.

A general lightening of exposure to the stock market is a prudent approach when earnings growth is slowing. Rising interest rates will open up investment opportunities in fixed income products such as Certificates of Deposit (CDs), but will hurt bond prices, since bonds go down in value as interest rates rise. Beyond shifting into cash during 2015 and buying real estate, there may be investment opportunities in foreign stock markets that have not rallied as much as United States stock markets. This is especially true in European stock markets, as fiscal stimulus by the European Central Bank and signs of a modest economic recovery in Europe may cause European shares to outperform United States shares during 2015.

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