The definition of a "corporate earnings recession" is two consecutive quarters of negative earnings-per-share (EPS) growth. Since 1990, the S&P 500 Index has experienced seven periods in which corporate EPS were negative. In recent time periods, the bursting of the tech bubble created negative EPS in 2001. In 2008 & 2009, corporations posted a string of eight negative EPS quarters.
Looking back at 2015, we see that each of the three final quarters in 2015 suffered a contraction. This means that we entered an earnings recession at the end of June 2015. The graphic below notes the corporate earnings recessions we have experienced since 1990 (highlighted in gray).
While we do not think we are entering an "economic recession" in which GDP contracts for two consecutive quarters, we do believe the shortfall in business activity will create a feedback loop into the overall economy, decreasing capital spending and corporate spending on labor. This business-led trend is something that we are watching closely.
If we look deeper into each sector within the S&P 500 Index, we see that the energy sector is largely to blame for the corporate decline in reported net income and EPS. We are monitoring the energy sector closely and looking for ripple effects that could spread to other aspects of our global markets.
As you know, we exited high yield bonds and floating bank debt bonds in late 2015. Post these adjustments, we are now running approximately 11-12% money market (cash allocation) within the portfolios.
Within our equity allocation, in early November 2015, we set the portfolios into a moderate equity underweight. Post this underweighting of equities, we further reduced risk by establishing a tactical market neutral equity allocation. This additional adjustment further reduced portfolio volatility. Looking into early February, we will look for relief rally opportunities to make additional adjustments to the portfolio.
Also, within equities we expect to exit small cap stocks. Smaller cap stocks tend to be more volatile than large cap stocks. Proceeds from our liquidation of small cap stocks will move into our tactical (defensive) equity allocation. In addition, we will establish a fundamental long/short position. This allocation has the ability to capture alpha (returns) in both positive and negative market environments with much less volatility.
Within our bond allocation, we will remain committed to our existing money market (cash) exposure. In addition, we will liquidate our short-term bond allocation and re-deploy these assets into traditional intermediate bonds. It is our belief that in the near term, traditional intermediate bonds will perform well in this environment of sluggish corporate and economic activity and accommodating monetary policy actions.
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Disclaimer: This blog is intended for informational purposes only and should not be construed as individual investment advice. Actual recommendations are provided by RAA following consultation and are custom-tailored to each investor’s unique needs and circumstances. The information contained herein is from sources believed to be accurate and reliable. However, RAA accepts no legal responsibility for any errors or omissions. Investments in stocks, bonds, and mutual funds may increase or decrease in value. Past performance is no guarantee of future results. Any of the charts and graphs included in this blog are not recommendations for the purchase and sale of any security.