As readers know, I think Durable Goods Orders are one of the best economic indicators available. Why? Because it’s real economic data, not a survey of business expectations like the ISM index. Durable Goods collapsed in June, down 4% from the prior month (versus expectations of -1.4%), the biggest drop since August, 2014. This represents a 6.6% decline from one year ago. Meanwhile, core durable goods orders have now posted year-over-year declines for 18 straight months, the longest streak of declines in U.S. history outside of a major recession.
Within the Durable Goods Report is a subset known as the Non-Defense Capital Goods Orders Ex. Aircraft, a number that closely approximates capital spending by businesses. Poor capital spending is one of the main reasons why the U.S. economy is failing to grow. Since recovering from the Great recession in 2011, capital spending has been trending steadily down.
Not surprisingly, a business sector that does not invest in itself doesn’t grow earnings. With 86% of the companies in the S&P 500 reporting earnings to date for Q2 2016, 69% have reported earnings above the mean estimate. Sounds good, right? Wrong. Earnings growth for Q2 2016 is negative — minus 3.5%. Earnings beat the estimates because companies took down their estimate just before the quarter ended, so they could ‘beat’ them. Based on the earnings reports to date for Q2, we are going to see five consecutive quarters of year-over-year declines in earnings for the first time since the financial crisis of Q3 2008 through Q3 2009.
According to FactSet, Q3 doesn’t look any better: 53 companies have issued negative EPS guidance so far compared to just 26 companies that have issued positive EPS guidance.
There is a growing divergence between the earnings and the share price performance of the S&P 500 as the chart below shows. This gap has to close. Either share prices have to fall or earnings have to soar. Tell me how earnings can soar when Durable Goods orders keep falling and American businesses aren’t investing in their own future?