Earnings Estimates For 2017 Fall

The stock market is at a standstill as it waits for the President’s speech where he addresses Congress Tuesday. Trump will be discussing the budget he will be submitting to Congress next month. We received a preview of the budget today as it was reported that defense spending will increase $54 billion or 10% from last year. The spending increase will be paid for by low level administration cuts. Foreign aid will also be cut. Most agencies will be cut with the biggest cuts coming from the EPA and the State Department. The great thing about cutting regulations is it also costs less to run the country without them. As with many speeches by politicians, because of the early information which has been reported, there won’t be many new policies. The keys to Trump’s speech will be filling in the details of proposed polices and providing the exact stance he has on some of the highly-debated issues such as the border adjusted tax.

I’m not sure how the overall market will react to Trump’s speech, but it has a big impact on how I view the stock market. Even with the expensive valuations, I must be more optimistic if regulations are being cut. The reason why I wasn’t optimistic after the election is because I wasn’t sure what to expect. Those who bought stocks in the after-hours market on Election Day made huge profits. They appear to have made a correct prediction on what a politician would do. In a sense, they deserve those quick profits because predicting what politicians will do is sometimes very difficult.

The other aspect I remain focused on is the earnings situation. FactSet updated their aggregate earnings information Friday along with the updated estimates. Last week was the opposite of two weeks ago. It was a bad week for earnings estimates, but a good one for reported earnings. Two weeks ago, the only reason why reported earnings were weak was because of AIG. In total, I’d give two weeks ago an A minus. Last week gets a C plus because of the downward revisions in estimates I will go over.

The earnings recession is officially over as 92% of companies have reported earnings in Q4 and growth is positive. Earnings growth has been positive two quarters in a row for the first time since Q4 2014-Q1 2015. The primary reason for the earnings declines was the crash in oil prices. There was also a mini industrial recession which looks to be recovering as the ISM Manufacturing report in January hit a 12-month high. The stock market had corrections during this earnings slowdown, but there weren’t any losses when the dust settled. The reason why stocks didn’t fall during the earnings recession was because of central bank intervention. It’s why stocks are so expensive now. It holds back the potential for a rally even though prospects have improved. Therefore, I am very hesitant to buy stocks even though the fiscal and monetary climate are beneficial them.

The chart below shows what I have mentioned previously. Earnings reports in the past week of data have been good. The dent that AIG put in Q4 earnings has mostly been recouped as year over year earnings growth increased from 4.6% to 4.9%. The past two quarter’s earnings growth has not come close to meeting the returns in stock prices, but the reason why stocks have rallied is because of the relative improvement. Stocks always look expensive at the depths of recessions because earnings are low. Earnings quickly recover and make it look like stocks were cheap in hindsight. The reason why this time was tricky is because there wasn’t an economic recession and stocks never went into a bear market.

The latest consumer discretionary earnings have made Q4 look much better than it looked in the recent past. Less than 1% growth has transformed into 3.1% year over year growth making the holiday sales appear to have been decent. This makes more sense because the retail sales data was relatively strong. It wasn’t a barn-burner Christmas season, but it wasn’t terrible either.

As I said the earnings estimates fell. They fell for both Q1 and full year 2017. The earnings growth in 2017 two weeks ago was expected to be 10.2% and last week it was expected to be 10.0%. This is a big change because the S&P 500 is already up 5.8% in two months. The estimates generally fall throughout the year which means below 10% growth is almost a guarantee. At the pace we’re at, the stock market will rise much faster than earnings growth which will make an expensive market even more overvalued. The decline in earnings growth came from energy estimates falling once again. It’s looking like my prediction was spot on in this area. Earnings estimates for energy in 2017 showed 290.3% growth 2 weeks ago and last week showed 284.9% growth. This is still the biggest contributor to earnings growth. However, if oil prices fall, it means the 10% S&P 500 earnings growth estimate is highly vulnerable. On the other hand, most industries benefit from lower oil prices, so the impact will be muted somewhat.

The FactSet chart below of bottom-up blended earnings for Q4 and estimates for Q1 confuses me. Even though the year over year earnings growth rate for Q4 increased 0.3%, the bottom-up blended results fell. There must’ve been a revision in last week’s data. The Q1 estimate also had a bump two weeks ago which wasn’t shown in the prior week’s chart. These revisions mean I can say both Q4 and Q1 bottom-up earnings fell while the stock market rose off the chart. It’s a bearish picture.

Conclusion

            Trump’s speech will be the headline on Tuesday. I think some people are thinking his infrastructure plan will increase the deficit, but I think it will rely on the cutting of red tape and allowing the private sector to do the heavy lifting. This is bullish because the infrastructure firms will profit without the taxpayer being on the hook for $1 trillion in spending.

The earnings estimates for 2017 fell. I have been anticipating 4%-6% earnings growth for 2017. However, tax cuts and regulatory reform make me think 2018 earnings will be better. Either way the stock market is more expensive than it has been historically based on trailing earnings and future estimates.