Drags from U.S. Dollar & Oil Should Ease
The U.S. dollar, should it remain near current levels, would be a potential tailwind for earnings in the third and fourth quarters of 2016, after representing as much as a 20% drag on foreign earnings in the second quarter of 2015 [Figure 2]. We do not expect a prolonged U.S. dollar rally as a result of Brexit, but that remains a risk to earnings in the coming months.
Should oil prices stay at current levels, the commodity would show year-over-year price gains in the third quarter of 2016 [Figure 3]; this, along with the significant capital spending and other cost reductions undertaken by oil and gas producers, could potentially enable the energy sector to reach consensus double-digit earnings gains by year-end and propel overall S&P 500 profit margins back to near record highs. A potential Brexit-driven rally in the U.S. dollar that drags oil prices lower is a risk.
Wages Remain in Check
Finally, although wage pressures are starting to build, and wages are the biggest component of companies’ cost structure, increases have been gradual. Wage inflation remains below levels of prior decades based on the government’s Employment Cost Index (ECI) for wages. The most recent ECI reading in the first quarter of 2016 increased 2.1% year over year (on an inflation-adjusted basis), compared to the 30-average of 3.0%. In the June payroll survey (released July 8), average hourly earnings rose 2.6%. So far, excluding the energy sector, S&P 500 companies have done an excellent job of absorbing wage increases over the past two years. As long as wage gains remain gradual, we do not see them as a material threat to corporate earnings.
Burt White is chief investment officer for LPL Financial.