Although the economy and the stock market are very different entities, they can and do intersect. Their health rely on some of the same fundamentals.
The S&P 500 is down about 12 percent from its high in May 2015. The index first crossed the 2,100 mark in February of that year and has been generally trending sideways since, though the market did have a sharp selloff and rebound between August and October. As recently as December 1, the index was still above 2,100.
Since December, the S&P 500 has sold off sharply. Reasons given in the press for the selloff range from China’s slowdown and attempts to change the regulations for its stock market, to collapsing energy and commodity prices, to a general softening of “risk appetite.”
Short-term fluctuations, including the recent double-digit percentage plunge, are difficult to fully explain and even more difficult to predict. However, over time, equity markets tend to be driven by fundamentals – sales, margins, and earnings.
That reality makes the quarterly ritual of earnings reporting so important. According to Factset, 161 companies – 32 percent - of the S&P 500 have reported fourth quarter earnings through January 27. The blended growth rate (blending actual reported data with the latest consensus expectation for those unreported) is -6.0 percent.
However, the decline masks a wide range of results among the sectors. Companies in the energy sector have led the declines with a 72.7 percent plunge in earnings. That sector alone accounts for 5.8 percentage points of the total 6.0 percent decline. Companies in the materials sector have a blended earnings rate of -25.9 percent. On the other side, telecom companies are showing a 28 percent increase, while consumer discretionary companies are posting a 6.4 percent increase.
We will be watching non-energy stocks closely for signs of underlying business strength, which could help keep the modest economic growth on track. On the other hand, it’s important to note that if earnings overall start to weaken significantly, companies could slow down hiring or begin to lay off workers.
Here at the American Institute for Economic Research, our Business-Cycle Conditions model is a data-centric, well-tested method for predicting recessions. In January, our index stood at 54, slightly above the neutral 50 point. Any prolonged deterioration in labor market conditions could turn the somewhat fragile economic outlook into a recession watch.