86% of S&P 500 Firms Beat EPS Estimates

Global Earnings Estimates Looks Strong

The only thing that matters to stocks is earnings growth. That’s the bottom line when it comes to analyzing geopolitical issues or trade skirmishes. With amazing earnings coming out as the tariffs are implemented, the market is getting less worried about the possibility of a demise in growth. Some arguments such as the worries about the flattening yield curve and the peak in earnings growth were misnomers because stocks do well after earnings growth peaks and they do well when the curve goes from 50 basis points to an inversion. Tariffs only matter if they are much larger than what they are now.

The emerging markets are levered to the industrial sector and the dollar. With weakness in industrials and a rising dollar, they fell. The dollar has been stagnant for 6 weeks, so emerging markets may end this correction soon. There also appears to be some green shoots in the Japanese and European economies. China is still a concern. The chart below shows the MSCI world country earnings consensus for the next 12 months. Despite the woes in China and the worries about trade wars, the earnings consensus is positive which means stocks should rally.

4 Fed Rate Hikes In 2018

The better international markets do, the more likely the Fed will raise rates 4 times in 2018. In this case, the better the news is, the more hawkish the Fed is. Rate hikes pull the next recession closer. With the recent optimism in markets, the chance of 4 rate hikes has increased to 55.6%. Since the chances rise with the stock market, I would expect 4 rate hikes to be a sure bet if the market breaks new records. The yield curve doesn’t have to invert, but it probably will if this occurs. The reason I say it doesn’t have to invert is because the long maturity bond yields could rise. It’s not as simple as saying the curve will flatten by 50 basis points with 2 rate hikes.

S&P 500 Q2 Earnings Season Is Underway

This is the first weak where many major companies are reporting earnings; the big financials get the ball rolling later in the week. Citigroup, Wells Fargo, and JP Morgan are reporting Friday morning and Bank of America is reporting on Monday. Investors are expecting big earnings growth from these firms. They had a bad quarter ever since they disappointed investors 3 months ago with reports that mostly beat estimates, but didn’t inspire confidence. So far, this earnings season looks great as 21 firms have reported results; 86% have beaten earnings estimates and 95% beat sales estimates. The average earnings growth rate is 24.1% and the average sales growth rate is 12.5%.

The chart below shows the recent trend in earnings growth. Keep in mind, the tax cuts mostly help earnings growth not sales. This improvement is because of the cyclical expansion which occurred after the 2016 mini recession. As you can see, if the Q2 growth rate is maintained, it will be another quarter of acceleration. I am strongly against the label which shows the ECB’s QE is responsible for the improvement in S&P 500 sales growth. If QE drove growth, why is growth expected to do so well in Q3 when the ECB will be ending its bond buying by the end of this year? There is going to be deceleration in 2019, but that’s not because of the ECB’s balance sheet alterations.

The point which shows accelerating revenue growth has justified stock price increases since 2016 is exactly correct. Even though stocks have done well and the CAPE ratio is high, I think stocks will only fall if there is a sharp decline in earnings. The only way the CAPE ratio would be low would be if investors completely ignored the earnings improvement in the past 2 years, giving the stock market a single digit PE multiple on forward earnings.

Company Outlook Is Strong

Q2 is the 2nd straight quarter where earnings estimates went up in the months leading up to earnings season. It is also expected to be the second straight quarter with over 20% earnings growth. At the end of Q2, the blended estimate for Q2 earnings growth was 20%. At the end of last quarter, the estimate was 17.1%. This means lower beats can still provide accelerated earnings growth. If this quarter is average, the estimates will be beat by 3.2% which equates to 23.2% in earnings growth which is 1.6% worse than Q1. This quarter needs to be better than average to show acceleration. Either way, Q3 will show acceleration as it will be the growth peak.

Currently, the estimate for earnings growth in Q3 is 21.7%. Even if there is a smaller improvement in estimates this quarter, it will likely show acceleration. This depends on how Q2 results come out. Keep in mind, if there are amazing results, the estimates in Q3 will probably increase. The chart below shows the company offered guidance index which is off the chart positive. To be clear, this index is the 3 month average of the up guidance minus the down guidance plus one half of the neutral guidance all divided by the total firms offering guidance. This amazing optimism destroys the notion that trade wars will knock down earnings growth. Firms have been mentioning they are worried about tariffs, but the bottom line is all that matters.

Conclusion

Everything looks good on the earnings front which means stocks should move up. Sometimes investors complicate matters by worrying about unimportant factors. If you follow the media, it’s easy to worry about unimportant factors because they report on stories which are negative to gain attention. Record corporate earnings aren’t as interesting as other stories, but boring results drive bull markets. Steer clear of the shocking reports which have no bearing on earnings and follow the improvements in analysts’ estimates by buying stocks or holding them if you already own them.

 

 

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