Stocks have staged an impressive rebound rally over the past three weeks, with the S&P 500 Index rising 9.2% from February’s low, but still down 3.2% year-to-date.
The upside move has been fueled in part by some better-than-expected economic data. Don’t get me wrong, the data remains downbeat, but isn’t as bad as many investors were expecting.
Case in point, the ADP employment report yesterday showed U.S. firms adding 214,000 jobs in February, which was a big positive surprise, well above estimates of 185,000.
As a result of this and other upbeat reports lately, the Citigroup Economic Surprise Index has turned sharply higher in recent weeks.
This is a gauge I follow closely, especially in turbulent markets. It measures the number of economic reports that come in better than expected (a positive surprise) compared with the number of data releases that disappoint (negative surprise).
When the line is below zero, as it still is today, it means more negative than positive surprises. But notice the steady uptrend in recent weeks. This tells me that while the majority of economic data is still missing expectations, the number of negative surprises is declining.
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In other words, the economy is getting “less bad” and that’s what
financial markets react to: Subtle shifts in sentiment!
So with the appearance of these “green shoots” for the U.S. economy, stocks, high-yield bonds, and other”risk” assets have rallied. But can it last?
That’s where I see more dark clouds gathering on the horizon, because S&P 500 earnings estimates are being slashed at an accelerating rate.
In fact, analysts are cutting first quarter 2016 profit estimates at the fastest pace in five years. Earnings estimates have plunged 9.6 percentage points in the last three months alone.
According to analyst estimates, S&P 500 earnings are on track to decline 8% during the upcoming first-quarter reporting season, and fall another 2% in the second quarter.
This would mark five straight quarters of contracting corporate profits. The magnitude of the decline in S&P 500 earnings is the worst since the global financial crisis, according to Bloomberg.
And history says this profit recession
points to trouble ahead for stocks!
Profits have fallen for five or more quarters only seven times since 1970, according to Bloomberg data, and six out of seven times the S&P ended up suffering a bear market decline of 20% or more.
Bottom line: Whether you want to blame a strong dollar, the collapse in oil prices, or declining global growth — the evidence of shrinking profits is clear to see and it calls into question the sustainability of the recent stock market rally.
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