Hello and welcome to the Custom Wealth Management 3rd Quarter Commentary for 2019.
To many of you I am a new face.
My name is Dan Bennett and I have been a Financial Advisor for 10 years. I recently joined the CWM team and I’d like to take this opportunity to introduce myself to all of you as well as welcome my clients to the firm. John will be back next quarter with the commentary but for now let's jump into it.
We have had a chance to digest all the numbers from Q3 and one thing jumped out to us. You may have seen reports that corporate earnings had beat estimates, which for many is a sign of a strong and growing economy. However, when we compare these numbers to prior years, last quarter's numbers actually showed a negative year over year growth and we saw the worst quarterly performance since the 2015-2016 earnings recession. This is important because much of stock market performance relies on earnings. To be able to maintain growth firms will need to be able to improve profitability. With increasing labor costs, a sluggish global economy and geopolitical uncertainty, the earnings landscape could be facing some headwinds.
As you may recall following the 2015-2016 earnings slump, we saw somewhat muted returns but rebounded nicely in 2017 and the first part of 2018. However, this recent earnings slump is different. Unlike the 2015-2016 weakness which was caused by crude oil price drops that affected primarily the energy sector, the current catalyst is shrinking operating margins caused by increasing wages and stagnant inflation. So as costs of operating continue to increase, revenues are flat. These shrinking margins are impacting a broad number of sectors.
The bounce back coming out of the 2015-2016 earnings period was also benefited by 2 other factors we are unlikely to see again: 1) the recent tax law change, which resulted in lower corporate and personal tax rates and helped improve profits and increased consumer spending and 2) the higher than usual level of corporate buy-backs in 2018 which helped elevate Earnings Per Share (EPS) growth.
On the international front, the world economy has also experienced a significant slowdown. Between global uncertainties, the potential for Brexit and the US-China trade war, international firms are having a tough time planning for even just the near future. This is resulting in widespread negative business sentiment across the globe. With many international firms experiencing late-cycle influences the UK and Germany (the two largest economies in Europe) have experienced negative GDP growth in the most recent quarter.
Against this backdrop, the next few quarters will be pivotal in determining whether this will be a quick and rather shallow earnings recession or the start of an extended period of chronically low earnings growth. If global economies miss their growth projections revenues could start to decline in an already tight margin environment. In effect this would stall earnings. It is possible that we will see a slight rebound in earnings in the next few quarters, however, should we see an economic slowdown, this could cause trouble for equity markets.
As with most things, the only thing we know for sure is that we don't know everything. The uncertainty of future earnings is just a reflection of the potential for volatility in the economy. If you watch the news you know there is no shortage of issues that could have a large economic impact. Even if issues like Brexit or the trade war come to a meaningful conclusion, it will take time for the markets to digest the results of these decisions.
All this uncertainty may lead to increased volatility going into 2020. And where there’s volatility, there is opportunity. If you would like to learn a little more about market volatility and why it can be a good thing, check out our recent blog post on our website by going to www.customwealthmanagement.com/resources.
During this time of year, we always like to pause and give thanks to you for your trust and confidence in our team.
With great gratitude from all of us at Custom Wealth Management, we want to wish you a very Happy Holiday Season.