In my last article, I discussed that we are dangerously close to global recession, as the services sector activity slumped in February 2016. This article discusses the impact on US corporate sector profits if the rest of the world enters recession.
The reason for this discussion is to underscore the point that even if US economic growth remains relatively resilient (driven by the consumption factor), global gloom will impact S&P 500 EPS outlook and, hence, broad market valuations.
While I don't expect US to remain resilient if there is a global recession, this analysis serves as a good optimistic-case scenario for US corporate profits.
The chart below shows gives the percentage of profits (with inventory valuation and capital consumption adjustments) that the US corporate sector derives from outside the United States.
While 2008 is an aberration, the US corporate sector derives at least 25% of profits from outside the United States. This is certainly not insignificant, and there will be noteworthy EPS adjustments if the rest of the world experiences recession. Therefore, investors need to remain cautious on fresh exposure to equities even if US economic growth remains relatively resilient.
I also want to focus on US corporate profit that comes from the financial sector, and the chart below shows that 19% of US corporate profit was from the financial sector.
If we are headed towards global recession, the financial sector is also likely to be impacted, and market volatility can work both ways when it comes to profits from trading. However, the bank's core business and income from credit growth will be impacted.
While I am not painting a doomsday scenario, I expect the S&P 500 to correct in the coming months, and I am therefore advising caution. In my view, it would not be surprising to see a 10-15% correction from current levels.