Round Up The Usual Suspects

by: S&P Dow Jones Indices

By David Blitzer

Movie fans may remember this as one of the closing lines in Casablanca. Though less artistic, market watchers have their own suspects for the stock markets turmoil of the last few weeks.

Corporate earnings are always a good place to start, and the latest projections point to 2015 EPS for the S&P 500 being down about 6% from 2014. The price-earnings ratio is about 19.2 times, higher than average and getting close to levels where people worry. However, more suspects are probably needed to explain the turmoil than weakening earnings when the projections for 2016 and 2017 are for earnings to increase 15-20% each year.

Oil would be a suspect except that there are far more consumers of oil than producers and the consumers are enjoying cheap energy. The details matter: for oil consumers, expenditures on energy are a modest part of their budget. The price drop is welcome but not life-changing. For oil producers, revenue from energy is a major part of their income, and the 75% drop is life-changing: layoffs, exploration cutbacks, turmoil in some petroleum exporting countries. Fears that problems in the energy sector will spread to other parts of the economy cannot be completely eliminated.

Then, there is China. China's growth was the engine of global growth in recent years; now, China's growth is slowing. Moreover, the government is trying to manage a shift from industrial development to a consumer-led economy. Its efforts to let the Chinese yuan gently depreciate and to encourage the stock market have met with difficulties. To be fair, government efforts to manage currency shifts are always fraught with difficulty. Successful government plans to influence stock markets are extremely rare. Achieving either in the midst of a major economic transition to a consumer-led economy would be almost miraculous. Japan tried as much in the 1990s - and hasn't completely recovered yet.

Earnings are weak, the Fed says it's raising interest rates, and everything we knew about oil and China two or three years ago is no longer true. No wonder the market is in turmoil.

Something more positive: Debt levels in the US are modest - after the 2007-2009 recession, businesses, households and the Federal government made efforts to reduce debts and deficits. This matters because high debt, along with falling stock and home prices, were the key causes of the Great Recession. The US is in better shape now than 2007. Then, there is history: the biggest stock market crash occurred on October 19, 1987, when the market fell over 20% in a day. From the late August peak to the close on October 19th, the market fell 33%. Then, it closed up 2% for the full year. If the numbers on the chart seem to be missing a digit or two, remember that was almost 30 years ago.

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