The 'Snap-Back Quarter' - How the U.S. Economy Fared in Q2 2015

Last night, we closed the books on the June quarter, and, in many ways, it was one that at the outset was expected to be better than the March quarter. However, as we learned, that wasn???t in the cards. For a variety of reasons, the second half turned out to be weaker than expected, and this was clearly reflected in the performance of the major stock market indices. The S&P 500, my preferred benchmark, closed the first half of the year up a paltry 0.2% — let???s be honest, that???s essentially flat for the first six months of the year.

Tracing back the index???s performance, however, we see it dipped modestly, some 0.2%, which reveals the market performance in the first quarter was actually stronger compared to that in the second. For those keeping score, the same pattern was had with the Dow Jones Industrial Average, which closed the first half down some 1.1% vs. its March-quarter end of down 0.3%. The only domestic market index that closed up in any meaningful way was the Nasdaq, which closed the middle of the year up 5.3% — better than its 3.5% return at the end of March.

What were the factors that led two of the three U.S. stock market indices to weaken in what was expected to be a ???snapback??? quarter as severe winter weather finally lifted and the fallout of the Pacific port closures was left behind? The quick answer is a U.S. economy that failed to live up to expectations. Signs were evident throughout the quarter, be it from indicators such as rail traffic and truck tonnage or for the more formal government statistics, such as industrial production, capacity utilization or consumer-facing ones like personal spending and retail sales. Granted, we saw some lift in the consumer-related metrics late in the second quarter, but for the quarter in total, things were weaker than many had expected back in March.

In sum, we could say that while the vector was up, the velocity was slow relative to expectations. It???s something like imagining you are driving a Ferrari when you???re really behind the wheel of a Yugo. That was affirmed for us in the recent June PMI readings, which showed U.S. manufacturing slowing to its lowest level since June 2013, while the U.S. service sector slowed once again in June and continued to weaken from its March peak. Buried in both reports were comments pointing to a more cautious outlook. In the services report, ???service providers signaled the least optimistic year-ahead outlook for business activity since March. The degree of confidence in June was also weaker than the average since the survey began in October 2009.???

On the one hand, there was weaker-than-expected demand, but on the other, U.S. companies continued to grapple with the holdover from 1Q 2015 that has been the stronger dollar. Those were particular callouts in the June manufacturing PMI report for the United States — ???Moreover, there were reports that softer output growth reflected a degree of caution about the business outlook, as well as concerns about the impact of the strong dollar on competitiveness. Although new orders from abroad stabilized in June, this followed declines in export sales during each of the previous two months.???

Given the European Central Bank???s stimulative powers and interest rate cuts by more than two dozen other countries thus far in 2015, it???s looking like U.S. companies will continue to be hampered by the strong dollar, at least until early 2016.


We also have the more recent Greek drama to fold into the mixing bowl, and as I???ve shared with my subscribers time and time again, the stock market simply does not like uncertainty. It was that recent drama, along with spillover concerns thanks to Puerto Rico and high debt levels in Spain, Italy and other countries, that has raised ???contagion??? concerns. Yet, if we look at the data, strength in both the Italian and Spanish economies continued in June, which lessens some of the contagion risk in my mind.

During the coming days, trading volumes will be light because of the July 4 holiday weekend that has domestic stock markets closed this Friday. Odds are trading volumes will drop significantly on Thursday afternoon once the June Employment Report is digested as people try to get an early jump on vacation plans. We also have what appears to be never-ending Greek drama and the upcoming July 5 referendum that will contribute to slower volumes.

Once we return from the holiday weekend, however, we will be facing, if not bracing for, 2Q 2015 earnings. Current expectations courtesy of FactSet call for S&P 500 earnings to decline by 4.5% for the June quarter. The last time the index reported a year-over-year decrease in earnings was Q3 2012. A note of caution here — significant buyback activity during the quarter could make bottom-line comparisons more favorable than operating profit performance would indicate. I???ll be sure to compare share counts — quarter over quarter and year over year — to distinguish between a true earnings beat and one that was for all intents and purposes manufactured by robust share buyback activity.

Even after the sharp drop in the indices during the last few days, the S&P 500 is still trading at 17.3x expected 2015 earnings of $119.50 per share. Some quick sandbox math shows those earnings are only expected to grow some 2% this year. Now, I could go on and on about that multiple vs. that level of earnings growth, particularly given the dollar and cautious outlooks in the near term, but the growing question as we move into the back half of the year will be S&P 500 earnings expectations for 2016. Currently those earnings are expected to grow 12% year over year, which would be strongest rate of growth since 2011.

The bottom line is we have several land mines still ahead of us, and given the usual summer slowdowns, we???re not likely to get a true picture of what lies ahead until September. While we???ve experienced that summer limbo before, this year it will likely feed uncertainty concerns and leave investors speculating once again about when the Fed will actually hike interest rates. The only difference is it will likely be from a beach, a lake or some other vacation site.

Even while I???m doing some of that in the coming weeks, I???ll continue to look at opportunities through my PowerTrend framework as I look to uncover recommendations for the second half of 2015 and into 2016.

Thematic headlines of the week. Each week, I digest a smattering of reports, surveys and other articles to make sure the tailwinds behind each of my PowerTrends, as well as my Growth & Dividend Report recommendations, are intact. As my subscribers know, when the thesis changes, we take action, which usually means booking profits, but every so often, it means limiting losses. Here are some of the items that caught my attention during the last week:

Enjoy the July 4 holiday with family, friends and loved ones, and I???ll see you back here next week for the next edition of PowerTrend Bulletin.

In case you missed it, I encourage you to read my e-letter column from last week about the four horsemen of the global economy. I also invite you to comment in the space provided below my commentary.

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