It’s no secret that energy and materials companies largely struggled throughout 2015. In fact, they were the worst performing sectors of the year. Weak fundamentals were driven by slowing demand, especially out of China, and oversupply as U.S. domestic crude oil production has nearly doubled during the last several years. Consecutive misses on the top- and bottom-lines, as well as the prospect of rising interest rates affected stock prices, as the S&P 500 Energy Index fell 25% during the year, and S&P 500 materials dropped 11%. The energy sector saw profits decline 49.1% in 2015 and revenues fell by 33.2%. Materials were the only other negative sector for the year, with EPS falling 2.5% and revenues of -11.3% (see “Energies and materials take it on the chin”).
During the fourth quarter of 2015, it was expected that year-over-year comparisons for energy names would be even as the dip in crude initially started in the fall of 2014. Instead, the situation got even worse at the end of the year. Brent crude tumbled an additional 31% in Q4 and WTI fell 19%. With crude oil currently trading in the $30 per barrel range—the lowest level since 2003—many experts say it will take years until it gets close to the $100 level that had become the norm in recent years, if it ever does. A heavy oversupply of oil has been responsible for pushing prices lower, but judging by the drop in exploration investments in the first quarter of 2016, that production appears to be decreasing—but just not quickly enough.
This, of course, meant major earnings declines for energy companies, with the oil, gas and consumable fuels industry falling 79.9% during the final quarter of the year, and energy equipment down 55.8%. These are companies that just a couple of years ago were enjoying record profits. As a result of the oil rout, nearly a quarter of a million industry workers have lost their jobs.
However, other sectors such as consumer discretionary, and even some industrials (airlines and transports and logistics) received a bit of a boost from lower-priced oil. The positive potential impact hasn’t fully been recognized yet, as consumers are not necessarily reallocating gasoline savings back into the economy, and transports have missed out on fuel surcharges.
Similarly, the S&P 500 Materials sector was negatively affected because of the metals and mining industry, which saw profits fall 62.9% in Q4 2015, with sales down 23.3%. Most of the weakness was in base metals, which are seen as a proxy for global growth and the health of manufacturing, as opposed to precious metals. These include steel, aluminum and iron ore, which are all used for industrial purposes. A decrease in demand reduced the price of the S&P 500 Metals & Mining Index by more than 50% in 2015. Miners tend to do well when economies are strong and there is less uncertainty, often accompanied by contracting credit spreads and a flattening yield curve.
The primary culprit of falling demand for metals has been China. China is the world’s largest importer of commodities, making it the biggest driver of global demand, and it is also the largest exporter of metals such as steel and aluminum. As demand for commodities falls, exporters make less money, which is not good for their economy. At the same time—because China is the world’s largest importer as well—their economic slowdown decreased worldwide demand for metals, thereby weakening prices.
The picture for these commodities doesn’t appear to be improving in 2016. Current estimates for energy EPS growth stand at -62.9%, with materials expected to come in at -1.7%. These are the main culprits for the impending earnings recession, with one quarter of negative EPS growth under the belt in Q4, and additional losses expected in Q1 and Q2 of 2016. The energy and materials sectors alone have led the S&P 500 to the lowest profit growth levels since the recession.