Since the beginning of 2016, investors have awakened to the limits of central banking monetary policy to increase faltering worldwide economic growth. It appears, the global central bank experiment of zero interest rate policy and quantitative easing over the past seven years has not built a sustainable economic recovery.
The “wealth effect” initially created by these policies had the desired effect of driving consumer spending higher and Gross Domestic Product (GDP) growth out of recession. Unfortunately even in the U.S., which has had the strongest recovery, consumer spending is weakening and GDP growth is slowing. Already the most anemic economic recovery in U.S. history, GDP growth is indicating possible recession as corporate profits decline and capital spending evaporates.
Outside the U.S., we view the economic picture far less rosy with China’s growth rates under extreme pressure, a banking and shadow banking system that is a house of cards, and markets under duress even with massive government intervention. Once the driver of growth in the world, China’s faltering economy is affecting other Asian, emerging market, and eurozone economies that have troubling economic problems of their own.
Oil’s price decline has been blamed for leading stock markets lower. We believe the declining price of oil is a symptom of economic weakness and the “demand vacuum” it has created. Excess supply is being driven by the cash flow needs of governments whose economy is primarily dependent on producing oil. As the price of oil falls, they have to produce more to get the same level of government revenue. Oil-producing economies are between the proverbial “rock and a hard place.” And we think it unlikely that oil prices will firm or move persistently higher until we see a resurgence in economic growth and the demand it will create.
We believe recessionary trends are bleeding over into developed markets and are driving investors to reevaluate risk and stock valuations. As fourth-quarter earnings season is coming to a close with most companies reporting negative earnings, we have further confirmation that corporate revenue and earnings trends are deteriorating. And even though stocks have fallen off their highs, they still aren’t cheap because earnings have declined more or less in line with stock prices. According to Dow Jones S&P, trailing price to earnings multiples (P/E) on the S&P 500 Index are still north of 20 times earnings (20.60) with about 70% of companies having reported fourth-quarter 2015 earnings. We think a more reasonable multiple with earnings still contracting might be 14 times, which would imply stocks could decline 32% from here.
It is time to reevaluate portfolio risk by taking some chips off the table. In market declines, we believe “cash is king” and may help insulate a portfolio by protecting capital from further declines. The only companies we would consider investing in today are dividend-paying stocks that still have rising trends in revenue and earnings. And these are getting harder to find with less than 30% of S&P 500 companies making the grade. If markets continue to decline, stocks with positive trends may hold up better by falling less.
Don Schreiber, Jr., is Founder of WBI Investments and manages $3.1 billion for advisors and their clients.
