Despite the latest mini-rally, about 7 per cent has been wiped off the value of the Dow Jones Industrial index through separate sell-offs in the early part of 2016. Anxieties over foundering oil markets, China's growth prospects, and the direction of US Federal Reserve monetary policy have spurred the most pronounced retreat from risk since the August correction. This year's earnngs season has sent out some mixed signals so investors will now be trying to assess whether these sell-offs are to be viewed in isolation or if they form part of a general cyclical downturn.
Recent analysis from Bank of America Merrill Lynch confirms US corporate earnings contracted by around 4 per cent in the final quarter of 2015. And with the bulk of the S&P 500 constituents having already reported, it is likely we'll witness three consecutive quarters of year-on-year earnings declines for the first time since the third quarter of 2009.
By the end of October it had become obvious that comparative earnings were under pressure, not least because of a marked increase in the number of downward revisions that were being pushed out beyond the fourth quarter into the 2016 calendar year. Of course, the relative decline in earnings growth doesn't mean companies aren't in the black, it’s just that growth expectations are being reined-in; the warning by Apple (NASDAQ:AAPL) that its iPhone sales would register their first year-on-year decline in the first three months of this year is perhaps the highest profile example.
A crude earnings decline
It's worth remembering that US industrials are still outpacing consensus earnings estimates, albeit at a rate well down on the 4.7 per cent five-year average. Nonetheless, the pull-back in the US is well established and there is no doubt that companies across the Atlantic are demonstrating more signs of strain, and that has put dividend pay-rates under greater pressure - sound familiar?
US stocks, especially those reliant on export remits, have been struggling in the face of sliding oil prices, slowing international growth and a strengthening dollar. Blended earnings growth for US-focused companies was four times that of rivals with more than half their top lines dependent on export markets. Though US exporters might be finding the going hard, an analysis of recent earnings figures points to wildly differing performance across sectors, with financials, utilities and, above all, energy dragging down average gains. With crude prices hitting the skids, the energy sector saw a year-on-year contraction equivalent to 72 per cent. Put another way, earnings growth would still be in positive territory if you discount the negative impact of the sector.
Skewed incentives and short-termism
Some will find reassurance in the earnings performance of corporate America once the negative effects of energy stocks are discounted, but with stock repurchases of US public companies at record levels, the proportion of organic earnings growth must surely be brought into question. In 2014, for instance, spending on buybacks and dividends surpassed combined net income for the first time outside of a recessionary period. Income stocks within the S&P 500 have pushed aggregate spending on share repurchases and dividends well beyond 100 per cent of their combined capital budgets since 2010, compared with a rate of around 40 per cent at the start of the 1990s. And it has been reported that Goldman Sachs recently informed its clients that buybacks were running at nearly a fifth of total trading volumes in the early part of this year.
By decreasing the number of shares outstanding, buybacks - largely prohibited until the deregulation of the 1980s - increase earnings per share, even when net income is flat. The problem is the overriding corporate objective is to maximise shareholders returns in the near-term, even if that diverts capital from long-term productive investments.
