Plow Horse Stuck in the Mud
Investments, Markets

Plow Horse Economy Stuck in the Mud

Remember when the economy was booming? It is probably a faint memory, at best. The U.S. economy has been stuck in either recession or slow growth for almost a decade now.

Some regions and industries have seen rapid growth. Silicon Valley, the cloud technology sector, and (until recently) shale energy production have all been bright spots. Nevertheless, most of the domestic economy has had to settle for steady but slow “Plow Horse” growth in recent years.

I began using the Plow Horse metaphor back in 2013. Reading old stories is always a little humbling, but most hold up well.

(7/26/2013) What Works in the Plow Horse Economy
(10/16/2013) Seasonal Trends Favor the Plow Horse Market
(12/26/2013) Plowhorsing into 2014
(2/26/2014) Wintry Weather Can’t Stop the Plow Horse Economy
(6/25/2014) Plow Horse Economy Breaks into Gallop
(10/8/2014) Economy Shifting from Plow Horse to Race Horse
(11/26/2014) The Plow Horse Economy Goes Shopping

I didn’t mention the Plow Horse much in 2015, perhaps because the economy was already slowing down. Now it is stuck in the mud.

Recent economic reports show a remarkable resemblance to this unlucky horse. New data from the Commerce Department said the U.S. economy grew at a 1% annualized pace in 2015’s last quarter. Consumer spending was lower than expected and business investment sank.

Meanwhile, the Conference Board’s Leading Economic Indicators index fell in January for the second month in a row, signaling the economic expansion will remain modest at best. Meanwhile, the Consumer Confidence Index fell to a seven-month low this month as Americans grew more pessimistic about job prospects and business conditions.

Being trapped in place may be preferable to going backwards, but it is not a position anyone envies. Nor is it easy to escape alone. A horse in this position will go nowhere until he gets help from shovel-wielding humans.

Who will help the Plow Horse Economy? In normal circumstances we would say the Federal Reserve, but its shovels are proving less effective these days. Quantitative easing had little impact outside the financial markets. The much-awaited December interest rate liftoff already looks like a mistake. Fed officials are openly wondering if a negative interest rate policy is the answer. Central banks in Europe and Japan are having little luck with NIRP, but are trying it for lack of any better choices.

Of course, it is quite possible for the stock market to move higher even if the economy moves sideways. A company’s stock price reflects the current value of its future profits. Unfortunately, those future profits look significantly less certain.

Wall Street’s quarterly earnings season is wrapping up right now and the results look terrible.

Only three of the ten sectors show positive earnings growth over the last year. In the Energy sector, sales dropped 34% and profits dropped 74%.

Some analysts argue we should look at the picture “ex-Energy,” since everyone knows the oil patch is in trouble. I think this is wishful thinking. Other sectors aren’t being demolished as badly as Energy, but we still see plenty of pain. Financials, Materials, Consumer Staples and even Technology are struggling to stay above water.

For the S&P 500 index as a whole – with 435 companies reporting – sales dropped 4.2% and earnings fell 6.5% since the same quarter a year ago. These earnings (or lack thereof) are a prime reason stocks retreated in January and have not recovered as we approach the end of February. We may not be in an economic recession yet, but the earnings recession is undeniably here.

In theory, the stock market is forward-looking. Prices reflect not only past experience but future expectations. Is there reason to believe corporate profits will pick up soon? I’ve seen many bullish arguments but none that strike me as plausible.

Two consecutive quarters of declining profits are a strong indicator of market weakness. We’ve now had three such quarters.

Data source: Hedgeye.com

When I combine this with the other technical indicators we’ve found reliable, I see abundant reasons to be cautious. This is why we began moving our Republic managed accounts into defensive positions back in December and they remain there today.

I would love nothing more than for the Plow Horse to shake off the mud and gallop once again. I’m confident he will, too – but he probably needs to rest a while first.

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