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Consumer Gain, Corporate Pain

Robert Johnson, CFA
Jeremy Glaser

Jeremy Glaser: For Morningstar, I'm Jeremey Glaser. There are a number of economic factors right now that are beneficial to the consumer but are really weighing on corporate results. I'm here with Bob Johnson, our director of economic analysis, to make sense of it all.

Bob, thanks for joining me.

Bob Johnson: It's great to be here today.

Glaser: So, we've seen, as we get into earnings season here, a bit of a bifurcation where consumers still seem pretty happy but management teams are mainly downbeat. Let's look at some of these factors and see who they are helping. The first is, of course, the strong dollar. What are you seeing in terms of the dollar impact on earnings so far?

Johnson: Well, it's been a little bit bigger than people have been thinking, and we've been talking about the dollar for a long time. Depending on which metric you use, it's 12% to 18% higher than it was just six to 12 months ago. So, it's been a big change in the dollar, and it's really come home to roost.

Just to pick one example, this week Procter & Gamble (PG) reported earnings which were particularly disappointing. And one of the things they cited was the currency. They talked about in the year ahead, with currency wrapped in, that revenues were going to be down 6% and profits 12% because of currency effects. So, it is certainly a big number, and a lot of S&P 500 companies have a lot of revenues in Europe. Even though there are a lot of staple businesses in the S&P 500 that don't have a European exposure; overall, it is something like 13% of S&P 500 revenues come out of Europe. So, that's a pretty big number. And certainly, with the currency going the wrong way, it's having some effects when we translate those back to the U.S.--and that's even before we consider that the products themselves probably aren't as price-competitive as they once were.

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Glaser: Consumers are certainly enjoying gasoline under $2 a gallon in many places, but maybe some of the corporations that are selling the gas and that are in the energy sector aren't. How are you seeing the impact of lower oil prices on businesses?

Johnson: Well, first of all, to your question about the energy part of it: There's been a huge impact, and we are talking about now, in the fourth quarter, we are likely to see no growth year over year in S&P 500 earnings. And the reason for that is because the [energy] sectors have been such a large negative--and even still a little bit of a negative surprise even after people started to factor things in.

So, clearly, it's had a very direct effect, and we are going to have one of the poorest improvements in earnings that we've seen this entire recovery, entirely just in the energy sector--besides the knock-on effects that we can talk about in some of the other business sectors. So, there is a direct effect there.

Then, this week, we saw the carryover effects on a company like Caterpillar (CAT). They have been hit every bad way that you can. They've always had a presence in the mining market, and that's been slowing for some time; now, oil and gas, which is kind of an engine of growth, has been slowing. Then, on this week's call, they were even saying, "Yeah, the mining equipment and the oil stuff's down, but you know, the towns that are next to all of that equipment in all of those sites aren't building houses as much, the construction has slowed down. And so, our regular construction equipment--not even oil-and-gas-related equipment--isn't selling all that well either." And then they've got currency, too. So, talk about getting hit in all directions, a perfect [storm] there for them.

Glaser: Now, Caterpillar is not the only manufacturer that's being hurt. When you look at the entire U.S. manufacturing sector, there are signs that things like low energy prices and the stronger dollar are really starting to take their toll.

Johnson: They are starting to. This week, we had the durable goods report and, again, it came on a day with some bad earnings and it really [contributed to] one of the worst stock market days we've seen for a while. Certainly, the durable goods report, on a headline basis, was down over 3%. Obviously, Boeing Airliners (BA) was part of that. And we always say you've got to toss that out; they are volatile from month to month. They've got an eight-year backlog, so they are going to keep producing what they can produce and what the orders are doesn't make any difference--at least, in the short term.

Even stripping those out, though, the durable goods orders were down over 1%, and this is the third month where we've been flat or down in durable goods. So, we are already beginning to see that. And what's really interesting is that you can't lay your hands on one easy category to say, "OK, how big is this sector and what's it doing to the numbers?" because the pipelines are in the tubular-steel part of the business or fabricated-metals part of the business; the software tools that help find the oil are in computers; the houses in North Dakota that are near the facilities are in the housing category. So, it's not an easy calculation, and I think we are starting to see some of those relationships in a more painful way than many people thought.

Glaser: So, we are seeing these painful things for businesses; but a lot of them, as we mentioned, were positive for consumers. What are we seeing in terms of consumer strength? Will they be able to spend their way to the point where the economy can kind of muddle through some of these other problems?

Johnson: I think that's probably going to happen. You know I don't like consumer confidence numbers, but we did have the numbers from the conference board [this week], and they were the best we've seen in the entire recovery. We were up well over 100 on that metric, which really blew away expectations. Again, it's probably more of a reflection that gasoline prices were down than what [consumers] actually may end up spending, but it was a barn burner of a number.

The second number that I think is really of interest and speaks to the strength of the consumer is the Apple (AAPL) earnings this week. The number of phones that they sold was 10% to 20% higher than what anybody had thought, so it was a wildly successful holiday season for them. And it's clear that where a lot of consumer dollars ended up was in iPhones. And I think one of the things we had worried a little bit about is that retail sales were a little funky, a little weak in the latest period. And now it's pretty clear that probably some of that went into the iPhone market instead, which gets rated in consumer services, not necessarily in the goods part of the GDP calculation. So, it's very interesting, and maybe that explains why the retail sales report looked so funky at the beginning of the month.

Glaser: So, it sounds like we could have these two countervailing forces with us for some time.

Johnson: Absolutely. And I've talked again and again about how we've had this disconnect between the U.S. economy and the U.S. consumer--with the consumer [making up] 70% of the U.S. economy, that's clearly what drives things here--and S&P 500 companies. We went through three or four years where the U.S. consumer and the U.S. economy did OK and limped along, while S&P earnings went through the roof. And now, we are starting to see, unfortunately, a little bit of payback, where S&P earnings are getting shellacked and the U.S. economy and the consumer are doing a little bit better.

Glaser: Bob, thanks for your insights on this today.

Johnson: Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.


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