S&P 500 - Should Investors Be Concerned?

The S&P 500 (SPX) is the most watched index on Wall Street. It helps investors to depict the general situation of the US economy. 2015 was a particularly tough year for the index as the markets waited for the Federal Reserve to hike interest rates, a move that would have been very harsh on all stocks except banks. The Fed did indeed hike rates for the first time in nearly a decade but, nevertheless, for the seventh straight year, the S&P 500 closed positively, although it was a paltry 1% higher. The index was thought to be in a solid bull cycle but again the markets reminded investors that stocks rarely move in a straight line. In 2016, the index has been drifting lower to current levels of around 1855. But should investors really go into panic mode?

Q4 S&P 500 Earnings Reports

Over two thirds of S&P 500 companies’ earnings reports are now behind us and it is now clear that Q4 would be the third consecutive quarter of negative earnings growth. This earnings swoon is a result of various factors: a slowing global economy, a strong US dollar (USD) and the plunging of oil prices which has caused grave problems in the Energy sector. The largest companies constituting the index are particularly vulnerable to these factors because it is estimated that they derive about 40% of their revenues from overseas.

The Energy and Materials sectors led the earnings plunge by reporting a -78.6% decrease in profits from last year as well as a -35.9% drop in revenues. This was largely expected because of low oil prices. The Technology and Industrial sector profits also fell with technology stocks on course to post an overall 0.1% dip. On the other hand, industrial stocks are expected to show a 1.8% dip as manufacturing slows down and international demand shrinks. The major technology companies reported that currency swings affected their revenues, with Apple Inc. reporting a $4.9 billion loss and Amazon a $1.2 billion loss.

The impact of the Fed rate hike seemingly never hit the consumer in Q4 with the sector reporting a 9.7% earnings growth. Automakers were the biggest gainers as consumers appreciated cheap gas and the unemployment rates remained at multiyear lows. However, the earnings of consumer companies such as Wal-Mart and Coca-Cola are expected to dip 1.8%, mainly because of the impact of a strong dollar on their overseas operations and not necessarily a contraction in the spending of the US consumer. Nonetheless, it remains to be seen whether the US consumer, who drives about 70% of the economy, will last the distance as the full effects of the Fed rate hike sink in. But as it stands, the drop in oil prices is helping to negate the threat of a stronger dollar.

Q4 Figures Beating Expectations

It is easy to read into the fourth quarter earnings figures and wish away the S&P 500. Nevertheless, taking a closer look, it is important to point out that 72% of companies have hitherto surpassed earnings estimates in relation to both the 1-year (69%) and 5-year (67%) averages. Additionally, 50% of reporting companies have topped analyst expectations - a figure that is consistent with the 1-year average (50%), although lower than the 5-year average (56%). Even though not particularly impressive, it shows that US companies remain resilient amidst the various challenges of a slowing global economy and a higher interest rate regime. This alone should ease the concerns investors have on the S&P 500 index.

The Strong US Dollar

There has been a recurring theme in recent earnings reports: a strong US dollar. The reason is simple - a strong dollar reduces the value of overseas sales revenues of the largest companies that make up the index. Compared to last year, the value of the US dollar index is approximately 11% higher and it is easy to see why most multinationals are lamenting. The index rallied sharply in 2015 and at the beginning of this year. However, after recent dovish comments from the Fed chair Janet Yellen, the index posted its largest 2-day decline in almost a decade as the markets priced out further rate hikes. This showed that the market is ready to embrace and support a weaker dollar and this should inspire a mini rally or, at the very least, stall the decline of the S&P 500.

Technical Viewpoint

In Q4 of 2015, the S&P 500 oscillated in a relatively tight range between 2000 and 2100 as investors anticipated a Fed rate hike. But early this year, the strong support of 2000 was broken as markets adjusted to the reality of a rate tightening era and low oil prices. The index slid to a low of 1804 before easing off a little bit. The slide of the S&P 500 index resumed in February but it has yet to take out the January low. Instead, the temporary support of 1812 has continued to hold the index in the wake of the Fed’s vagueness on further rate hikes this year.

The general technical picture of the S&P 500 is not as grim as it has been made out to appear. We are not in a technical long term bear run, which is defined as a 20% fall from highs. A 20% fall from the highs would mean that the index should achieve 1560 but even then (although we do not expect this to happen), this would not be a terrible scenario considering the S&P 500 has been in a solid 6-year bull run. We If oil prices would stabilize (there are positive signs of this happening with the $28 price level holding last week) and the dollar continues to weaken, a minor cheer should be expected in the S&P 500.

What to Expect in 2016

As of the beginning of the week from the 15th of February, the earnings growth of Q1 2016 for the Energy sector is expected to be -87%, down from -61% the previous week. The estimates might be scary but overall, the Energy sector is down approximately 7% YTD compared to the Financial sector which is down 15% and the Technology Sector by 11%. For short term investors, this is a concern but for long term investors, there is no reason to fear. The stock market is always a long term bull market with history proving time and gain that even the biggest drops ultimately give way to long term gains. A recent example would be the 2008 global recession where the index shed more than a third of its value but investors who held on have witnessed the index grow at an annualized rate of 4.3% since then. Although these are tough times, we are seemingly not in a full blown recession as was the case in 2008 and investors should lessen their worries.

Even then, no investor would want to buy a stock and watch on as its value shrinks. That is why most analysts now advise investors to adopt a wait-and-see approach on most stocks. Nonetheless, there are still other markets where investors can continue to engage in and make decent returns in the current conditions. Particularly, investors can learn more about binary options trading where they can trade their favorite S&P 500 stocks and the index itself profitably regardless of the market direction.