Back in early December, when the oil plunge and the dollar surge were not nearly as acute as they are now, we reported that just as a result of these two critical factors, an earnings (if not outright economic, for now) recession is on deck. Since then things have gone from bad to worse, as both the USD strength has continued (and as we wrote yesterday has become the one topic Goldman's clients are most concerned about), the oil plunge has resumed after a brief "dead crude bounce", and as we also first reported last month, for the first time since Lehman, full year 2015 revenues are now projected to decline.
Throughout all of this however one thing was constant: no matter how bad the overall profitability picture got, S&P500 earnings per share (assisted almost exclusively by a record amount of stock buybacks in 2015 putting downward pressure on the PS in EPS) would grow by the tiniest of amounts, just so the profit recession stigma could be avoided in a world in which the stock market is the last remaining bastion of faith in central planning and confidence in the economy.
No more. Overnight, Deutsche Bank finally did the unthinkable, and "broke the seal" of optimistic groupthink, when its strategist David Bianco became the first sell-sider to forecast that not only will 2015 EPS not grow (at 118 on a non-GAAP basis, this will be unchanged Y/Y), but "down a bit ex bank litigation costs."
We cut 2015E S&P EPS to $118 from $120 on rapid dollar appreciation
Accelerated dollar appreciation makes our prior 2015E S&P EPS of $120 hard to achieve. We assumed Euro averages $1.10-1.15 in 2015 and DXY 90-95. We now assume ~$1.05 and 100. Continued strong US job growth despite still slow GDP has put the first Fed hike credibly on the horizon, which underlies recent dollar gains. We think the Fed will soon communicate intentions to hike, but slowly and to plateau at a level below historical norms, which should slow dollar gains. Although we've been ahead of curve, we cut our 2015E S&P EPS again to $118, on new FX assumptions and ~$50/bbl avg. WTI oil in 2015.
Ironically, for Goldman these identical assumptions suggest a net offset to the negatives and positives, and yet for DB both are "unambiguously bad." So much for the propaganda narrative, which we mocked for 3 months and were proven yet again correct.
Flat is impressive: Energy down 45%, ~$12 of FX and oil price EPS headwind
2015E S&P EPS of $118 is flat from 2014 or down a bit ex bank litigation costs; which is respectable given enormous headwinds. S&P EPS would have been ~$130 w/ ~3% US GDP ex these factors. Nevertheless, this dollar reset and even much of the oil price plunge appears structural and unlikely to reverse anytime soon. This makes 2015 a year of lost S&P EPS growth, but normal EPS growth should resume in 2016.
So with EPS growth in 2015 now a wash (if not negative), which implies the only upside for the S&P500 will once again comes from substantial multiple expansion, beyond the already "99 percentile" 18x, where does DB expect earnings to grow?
We expect only two sectors to deliver 10%+ EPS growth in 2015: Financials at 12% or 7% ex. litigation and net of assumed higher loan loss provisions and Con. Disc. at 11% or 8% ex Auto. Health Care is at 5.5% EPS growth and all other sectors are at 1- 4%.
Uhm, why ex-litigation? Does anyone realistically believe that the criminal syndicate known as "banks", which have seen nearly $200 billion in recurring, non-one time legal fees also known as government kickbacks...
... to avoid sending bankers to prison, will end this government racket, and instead opt to see members of their own syndicate incarcerated? We didn't think so.
As for what won't work, well... "Energy down 45%." So yeah, unambiguously bad.
Some parting words from David Bianco who used to be one of the biggest permabulls on the street, and now appears to have taken the place of what David Rosenberg used to be once upon a time at Merrill Lynch, the sellside's reluctant skeptic.
Flat S&P EPS, above avg. PE, Fed likely to hike: How 10yr yields react is key
It’s true that the S&P is typically positively correlated to early-cycle Fed hikes and a rising dollar, provided dollar strength isn’t from a flight to safety. However, the S&P is also positively correlated to EPS. This upcoming first Fed hike since the recession ended will not be accompanied with the usual surge in EPS. The S&P’s current PE is 10-15% above history and we don’t consider S&P EPS below potential anywhere other than at Energy and it’s rare for the PE to rise while the Fed hikes. Thus, we think the key to S&P performance is how long-term Treasury yields react to Fed hikes. If 10yr Treasury yields rise just modestly as the Fed hikes and look likely to stay below 3% through 2016, then we can justify current PEs with some upside at sectors that can generate decent EPS growth despite FX headwinds such as Tech and Health Care.
Historically there were periods of PE expansion accompanied by strengthening dollar and vice versa, but how dollar affects PE depends on current level and direction of inflation and interest rates, current PE, and EPS outlook. In early to mid 1980s, a strong dollar was welcomed by investors as it lowered inflation and interest rates from very high levels, and PE was at a very low 7-9x level and it climbed back to its historic norm (see figure 13 for years 1984-1986).
As a result, this is what DB's latest EPS outlook looks like:
Soaring dollar, plunging oil: unambiguously bad.
Finally, this is how periods of USD strength, or weakness, impacted the S&P500: