S&P 500 companies are on track for 10% growth in the second quarter, and investors and pundits are excited. But the aggregated number is masking the weakness in a key sector that should give investors pause.
The gains are being driven by energy, which is enjoying easy comparisons, to use an analyst term, meaning it is rebounding from a very low base. In the more than two years that oil prices have held at stubbornly low levels, energy companies have gone through a period of restructuring, slashing capex budgets, selling assets and ditching noncore businesses.
The other star sector is technology, driven by the so-called FANG stocks — Facebook Inc., Apple Inc., Netflix Inc. and Google, whose parent company is Alphabet Inc. — alongside chip makers. Companies like Nvidia Inc. and Advanced Micro Devices Inc. are enjoying strong growth thanks to the self-driving trend, videogaming, the rise of artificial intelligence and cryptocurrencies.
The only sector that is showing an earnings decline is consumer discretionary, which is being battered by the carnage in the retail sector as Amazon.com Inc. razes everything in its path, and as consumers rein in spending amid a spike in health care and rental costs. The last time the consumer discretionary suffered an earnings decline was the third quarter of 2014.
And the consumer-staples sector is the weakest of those showing year-over-year gains, at 3.4% through Friday, according to FactSet.
That means that all is not quite right with the consumer, who sits at the very heart of the U.S. economy and is the main driver of growth.
“Consumer spending is just OK at this point — it’s not robust,” David Joy, chief market strategist at Ameriprise, told MarketWatch. “Wage growth is pretty subdued, so that may be causing people to be somewhat circumspect.”
The consumer-discretionary sector carries just a 12% weighting in the S&P 500 index, according to S&P Dow Jones Indices, and including the 8.7% weighting of the consumer-staples sector, the consumer barely makes up one-fifth of the benchmark index. But for the economy, and therefore the broader stock market, the influence of the consumer is much greater.
Consumer spending totaled $13.3 trillion during the second quarter, or 69% of the $19.2 trillion gross domestic product, according to the Department of Commerce’s Bureau of Economic Analysis.
The SPDR Consumer Discretionary Select Sector exchange-traded fund has lost 0.1% in 2017, and the SPDR Consumer Staples ETF has inched up 0.3%, while the S&P 500 has climbed 9.2%.
For all the ballyhoo from the White House about the administration’s achievements, the reality is that Washington is paralyzed, with Republicans unable to push through the key planks of their agenda, and that is stopping some companies in their tracks.
“It seems policy uncertainty is more elevated now than it has been,” said Ameriprise’s Joy. “Clearly, the uncertainty around the tax code, the uncertainty of the nature of health care, has to have a chilling effect on decision making around those sectors.”
Companies in the S&P 500 generated a cash surplus of $60 billion during the second quarter, compared with a $22 billion deficit to investment spending over the last 12 months, according to data provided by J.P. Morgan. The bank’s U.S. strategist, Dubravko Lakos-Bujas, said policy uncertainty is partly to blame for the recent subdued investment activity, as is the rising cost of capital and rich multiples.
An analysis of earnings conference calls confirms the trend. The number of mentions of the Trump administration in the transcripts of earnings calls has fallen sharply since the fourth quarter, according to Sentieo, a financial research platform.
Sentieo counted 582 mentions of the administration on fourth-quarter calls, followed by 376 mentions on first-quarter calls and just 139 mentions on second-quarter calls. Mentions of tax reform fell from 39 in the fourth quarter to 14 in the first and just one in the second quarter.
Health-care mentions slid from 13 in the fourth quarter to 10 in the first quarter and just one in the second quarter. Infrastructure spending mentions went from 39 to 23 to 11.
John Butters, senior earnings analyst at FactSet, said he believes the decline in “Trump” or “administration” citations over the past six months is a sign that “corporations are less confident today relative to the start of the year that the policies proposed by President Trump will be enacted in the near future.”
The same pattern can be found in 10-K and 10-Q filings with the Securities and Exchange Commission. Trump overall was mentioned 445 times in the fourth quarter, 462 times in the second quarter and 232 times in the second quarter.
“The data continues to show the same trends that we’ve seen so far — after strong interest earlier in the year, disillusionment is taking hold as the market realizes that most if not all the initiatives will take an awful amount of time,” according to Sentieo.