The 25th anniversary of the 1987 crash, 19 October, was the worst day for US stocks in four months. The Dow Jones and S&P 500 indices slid by almost 2%. Early this week there were further declines. And it had all been going so well. There was talk of a new record for the S&P 500 soon. It peaked at 1,565 in late 2007 and is now 10% below that level.
Investors were in need of a wake-up call. America has been widely seen as “the cleanest dirty shirt”, as fund manager Pimco’s Bill Gross puts it. Its steady, albeit unspectacular, recovery looked appealing compared to receding Europe and slowing China. And all assets are currently “being lifted by the flood of cheap money”, says Martin Spring in his On Target newsletter.
But ultimately, says Spring, stock prices depend on earnings, and those are driven by economic growth. With companies now reporting on their third quarter, it has become impossible to ignore that there is precious little growth around – whether in America or outside it, where S&P 500 firms make around 50% of their sales.
US firms are in particular need of revenue growth to boost profits, as margins are near historic highs. “Cutting costs and shrinking assets only does so much,” says Agnes T Crane on Breakingviews. But two-thirds of the firms that have reported so far have missed their third-quarter revenue estimates.
Early this week, with around a fifth of all firms having reported, under half had met earnings expectations – the worst figure since the depths of the crisis in 2009. Expectations had been scaled back in any case: many had pencilled in the first year-on-year decline in profits in three years. General Electric, McDonald’s, DuPont and 3M were notable disappointments, as was the technology sector.
While the global growth outlook dims, a huge fiscal squeeze (the ‘fiscal cliff’) is set to kick in automatically in January if a divided post-election Congress can’t agree to put off or alter the $600bn package of tax rises and spending cuts that would push the economy back into recession. “The evidence from the campaign trail is [that America’s politicians] most certainly could… be so dim” as to hurtle off the cliff, says Tom Stevenson in The Sunday Telegraph.
Finally, while European stocks are cheap enough to be good long-term buys, their American counterparts aren’t: the S&P’s cyclically adjusted price/earnings ratio is still a historically high 21. So Wall Street looks especially vulnerable to setbacks in the next few weeks and months.