A Triple Reversal Strengthens Earnings
July 06, 2017
The global economy has strengthened over the last year, driving faster earnings growth and the stock market’s recent rally. What’s behind the recovery?
Several factors that had been a drag on global economic activity reversed, leading to the accelerating earnings growth and global equity market returns of 19% over the last 12 months.
The first factor was a strong US dollar. Beginning in the summer of 2014, investors began to expect that the US Federal Reserve would increase interest rates, while other central banks remained accommodative. This divergence led to a 25% appreciation in the US dollar, as the Display below shows
, which dragged down the earnings of US multinational companies that sell overseas and convert their profits back into US dollars. It also raised concerns about the sustainability of US dollar-denominated debt issued by non-US corporations.
More recently, however, benign inflation data caused investors to dial back expectations of monetary policy divergence, and the US dollar declined 6% from its 2016 peak, as the Display also shows. The lower US dollar improved US corporate sentiment and contributed to the 12% earnings growth for the S&P 500 in the first quarter of 2017 versus the year-earlier quarter.
Another factor that suppressed global earnings growth in recent years was the precipitous fall in oil prices. After peaking above $100 per barrel in June 2014, the price of oil plunged to below $30 over the subsequent 20 months, as the next Display shows, raising fears of deflation and slow economic growth. More recently, prices have stabilized in the $40 to $50 range, driving a rebound in energy companies’ earnings and capital spending, and abating fears of deflation.
Finally, global manufacturing activity slowed in much of 2016 as companies pared inventories that had built up in 2015. Once the inventory adjustment was complete, steady sales growth drove increased production in the second half of 2016 that continued into 2017. While global inventory growth exceeded sales growth by about 5% in the first quarter of 2016, in the first quarter of 2017 the opposite occurred: Sales growth exceeded inventory build by 3%.
The reversals in the dollar, oil, and inventory trends spurred a corporate profit rebound, and capital spending started to recover. Current expectations call for earnings growth in the mid-teens for 2017, up from the low single digits over the last 12 months.
We believe that the global economy’s steady growth could continue for some time, but wage inflation, rising interest rates, and the Fed’s plan to reduce its huge balance sheet pose risks to this scenario. If these risks don’t materialize, the economic expansion and market recovery could continue—perhaps for longer than expected.
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.