The first-quarter earnings season, which started this week, is going to be a difficult one. Nevertheless, we think investors should remain positive on the prospects for U.S. stocks ahead of a likely pick-up in profits in the second half of this year.
PYMCA | UIG | Getty Images
Corporate results are likely to confirm that large listed U.S. companies remained in a so-called earnings recession in the first three months of this year. Profits posted by S&P 500 companies are likely to have decreased for the third straight quarter — 5 percent according to our estimates, and 8 percent according to the analysts' consensus estimate by Bloomberg. This also comes in the context of a slight decline in S&P 500 earnings per share last year, to $118.35 from $119.05 the year before.
However, we feel U.S. equity earnings are likely to recover in the second half of 2016, and we have recently become more positive on the prospects for U.S. stocks. Here are three reasons why:
Stabilizing oil prices. Collapsing oil prices have been a major drag on U.S. energy, which in turn has brought down U.S. profits overall. Nevertheless, stabilizing oil prices and healthy activity outside the energy sector should help earnings recover this year.
Although oil prices, as measured by the Brent crude benchmark, could suffer a relapse in the second quarter, we believe they will probably bounce back to $55 a barrel in 12 months as the surplus in the oil market disappears in the second half of this year. Oil prices should become a tailwind for profits, not a headwind. In addition, large energy write-downs of $100 billion caused a discrepancy in Generally Accepted Accounting Principles (GAAP) and adjusted earnings in 2015. This gap should close this year as oil prices rise.
The recovery in energy earnings should be supported by growth outside of the sector. Excluding energy, S&P 500 earnings per share rose 7 percent in 2015. Technology, financials, health-care, and sectors that benefit from discretionary consumer spending like luxury goods saw earnings rise 10 percent. Together, these industries represent two-thirds of the earnings picture.
Fading pressures from the U.S. dollar. The U.S. dollar rose 16 percent on a trade-weighted basis last year. For U.S. companies, this caused the U.S. dollar value of overseas profits to fall, which held back earnings growth by about 3 percent last year.
However, we think the U.S. dollar has much less room to appreciate this year as the U.S. adjusts to a more gradual timetable for rate hikes, among other factors. Consequently, international earnings at large U.S. corporations should be a better contributor to profit growth in future.
Improving economy. As the labor market improves in 2016 and wages rise, U.S. GDP growth and domestic consumption should make progress.
However, inflation in wages and consumer prices is likely to remain moderate, which will ensure the impact on corporate profit margins remains low.
More than 6 million Americans work part-time because they can't find full-time jobs, according to the Bureau of Labor Statistics. That is 50 percent more than a decade ago. This suggests the labor market still has enough slack to allow for further job growth without inflation getting out of hand.
The picture for first-quarter earnings may not be ideal, but markets have already priced in a worse scenario than we anticipate, paving the way for potential future gains. Our forecast for first quarter earnings is less pessimistic than the rest of the industry. Beyond the first quarter, we see S&P 500 earnings growing 3 percent this year and 7 percent in 2017.
Commentary by Mark Haefele, global chief investment officer at UBS Wealth Management, overseeing the investment strategy for $2 trillion in invested assets. Follow UBS on Twitter @UBSamericas.
For the latest commentary on the markets in the U.S. and around the world, follow @cnbcopinion on Twitter.