Earnings Recession To Sustain; Expect Market Correction

On April 8, 2016, FactSet earnings insight report for the S&P 500 estimates 1Q16 earnings to decline by 9.1%. If this holds true, this will be first time since 3Q09 that the index will see four consecutive quarters of year-over-year declines in earnings.

The chart below shows the estimated earnings growth and the actual growth from 2Q13 to 4Q15. Clearly, the year 2015 was not healthy for the corporate sector and I will not be surprised if the earnings recession trend sustains beyond 1Q16 with global factors also remaining unsupportive.

I have been arguing in the recent past that the global economy has slowed down meaningfully and US GDP growth for 1Q16 is also likely to disappoint. The corporate earnings recession adds to the woes for the broad markets and I expect at least 10% to 15% correction for the S&P 500 index in the next 3-6 months.

My view is backed by the following observation on market valuation from the same FactSet earnings insight report by FactSet – “The forward 12-month P/E ratio is 16.7. This P/E ratio is above the 5-year average (14.4) and the 10-year average (14.2).”

It is entirely likely that the PE will trend towards the long-term average as the possibility of negative earnings surprise also increase for 1Q16.

From an investment perspective, it would be better to avoid fresh exposure to the index and wait for meaningful correction. I must mention here that the prospects of renewed expansionary monetary policies can limit the downside, but easy money will not be enough to support the markets if earnings growth continues to disappoint.