Earnings I: For Homebodies. For a change, let’s ignore Washington. Let’s ignore the Republicans and the Democrats.
Let’s ignore the White House, Congress, and K Street. That’s what the financial markets were doing for the past eight years. Investors were focusing most of the time on the Fed and the other central banks. Now we are all being forced to participate (in one way or the other, though mostly as observers) in the greatest circus of all times. I guess that is only fitting now that Ringling Brothers is going out of business. Instead it will be Cirque du Trump 24x7 for the next four years.
Of course, over the past eight years, stock market investors also have been focused on earnings, as they always are. While the 6.6% rally in the S&P 500 after Election Day through Tuesday’s record high of 2280.07 might have had a lot to do with the results of that day, it helps that the earnings outlook has been improving. In our 8/22 Morning Briefing, Joe and I declared that the earnings recession was over, and that it was mostly attributable to the S&P 500 Energy sector as a result of the plunge in oil prices from mid-2014 through early 2016.
Let’s analyze earnings under America First (since that is the PC thing to do these days), then we can go global (at the risk of having to pay a border tax when we come back home). Consider the following:
(1) Earnings. On a year-over-year basis, S&P 500 operating earnings, based on Thomson Reuters (TR) data, showed declines from Q3-2015 through Q2-2016 (Fig. 1). It rose 4.1% during Q3-2016, and probably rose around 6.0% during Q4-2016.
Arguably, the earnings recession ended earlier than suggested by the growth rate based on the actual level of operating earnings (TR basis), which bottomed during Q1-2016, declining 11.7% from the previous record high during Q4-2014. It is up 15.8% from that recent bottom through Q3-2016 to a new record high (Fig. 2).
(2) Revenues. On a year-over basis, S&P 500 revenues declined from Q1-2015 through Q4-2015 (Fig. 3). It edged up during the first half of 2016, and was up 2.5% y/y during Q3-2016. This too suggests that the earnings recession actually ended in early 2016.
(3) Q4 reporting season. So far this earnings-reporting season, i.e., through the 1/19 week, the blended earnings number (including both reported and estimated figures) shows a gain of 4.7%, up from 4.1% the previous quarter. Joe and I are expecting the traditional upward “hook” in actual earnings relative to expected earnings for the current earnings season, which is why we predict that the actual growth rate will be close to 6.0%.
(4) Forward ho! S&P 500 forward operating earnings per share, which is the time-weighted average of consensus expected earnings for the current and next year, rose to $133.65 during the 1/19 week (Fig. 4). That’s a fresh record high and a good leading indicator for actual earnings as long as there is no recession coming over the next 12 months (Fig. 5).
The consensus estimate for 2018 has been moving higher in recent weeks, which doesn’t usually happen, as optimistically biased analysts typically lower their distant forecasts as reality approaches. Analysts may be starting to incorporate tax cuts and less regulation into their 2018 estimates. They now expect that 2018 earnings will rise 12.0%, following this year’s gain of 12.3%.
The analysts may also be raising their economic growth expectations, as evidenced by the firming in their 2017 and 2018 estimates for S&P 500 revenues, which are showing gains of 5.8% this year and 4.9% next year (Fig. 6). Forward revenues is also rising in record-high territory.
As Joe observed yesterday, the three forward earnings series for the S&P 500/400/600 continued to trend higher in record-high territory during the 1/19 week (Fig. 7).
(5) Sectors leading and lagging. The S&P 500 Net Earnings Revision Index (NERI) that Joe calculates turned much less negative over the past eight months through January (Fig. 8). While negative NERIs are the norm during recessions, NERIs also tend to be negative during maturing expansions, after they turn positive during the initial recovery periods. That reflects the optimistic bias of analysts during good times.
A glance at the S&P 500 sectors shows that most of the recent improvement has occurred in three sectors with positive NERIs, namely Energy, Financials, and Information Technology (Fig. 9). The following seven sectors remain in negative territory: Consumer Discretionary, Consumer Staples, Health Care, Industrials, Materials, Telecom Services, and Utilities.
An analysis of the sectors’ forward earnings shows that over the past 6-12 months, the sectors with the best upward momentum are Energy, Financials, and Information Technology (Fig. 10). The others are mostly trending higher at a slow pace.
(6) Going big. Before Election Day, Joe and I predicted that S&P 500 earnings would be $129.00 per share in 2017 and $136.75 in 2018. After Election Day, on December 13, Joe and I concluded that there is a very good chance that the new Republican administration would succeed in lowering corporate tax rates and reducing costly government regulations on business given that the Republicans also won majorities in both houses of Congress. We assumed that this will happen this summer or fall and be retroactive to the beginning of this year. So we raised our earnings estimates to $142.00 and $150.00. We did get some pushback on timing, suggesting that the changes might not take effect until 2018. By the time we all know this, it won’t matter much to the market, in our opinion. The important thing is that it happens.
Of course, the downside is that the new administration’s trade policies might be too protectionist and bad for the economy. Trump is talking about a “border tax” rather than Paul Ryan’s “border tax adjustment,” which he said is too complicated. My hunch is that once the new administration renegotiates NAFTA, this issue will dissipate in importance. Then again, Trump did pull out of the TPP, which is widely viewed as consistent with his opposition to free trade treaties. Of course, he might renegotiate that one too. (Sorry that I violated my promise not to discuss Washington today, but it’s hard to avoid doing so.)
Earnings II: For Globalists. Needless to say for the S&P 500 component companies, America First isn’t their business model since they get roughly half their revenues from abroad. Nevertheless, they are mostly managed by experienced executives who have had to deal with Washington’s latest hare-brained schemes for quite some time. Over the past eight years, they’ve had to contend with an onslaught of government regulations. Now with the new administration, they might get significant relief on this front, but face some new challenges over the protectionist inclinations of the Trump team.
My hunch is that this too shall pass. The administration’s protectionism won’t be as bad as feared, and US businesses will deal with the latest challenges thrown at them by Washington. Meanwhile, both the latest economic and earnings data suggest that the global economy is picking up:
(1) Going global. Given the “America First” mantra of the new Trump administration, Joe and I should be feeling quite comfortable with our long-held “Stay Home” investment recommendation. The alternative is to “Go Global.” We keep getting cabin fever, and looking to go abroad for at least a short visit. After all, valuation multiples are lower overseas for the major MSCI stock market indexes: US (17.4), Japan (14.5), UK (14.5), EMU (14.2), and Emerging Markets (11.9) (Fig. 11).
Of course, when investing abroad, an investor has to get right both the stock index and the currency, or at least hedge against it. The ratio of the US MSCI to the All Country World ex-US MSCI remains on a strong upward trend that started in 2010 (Fig. 12). That’s more the case when the latter is priced in dollars than in local currency.
(2) Moving forward abroad. Our Blue Angels analysis for the ACW ex-US MSCI shows that the index’s forward earnings (in local currency) has been rising since the spring of 2016, though it remains in a flat range since 2011 (Fig. 13). The forward revenues picture for the index is also a bit brighter, but nowhere near record-setting levels as for US S&P 500 (Fig. 14).
(3) Flash dancers. Most encouraging for both the US and global economies is January’s batch of flash M-PMIs, which Debbie discusses below (Fig. 15). The US index rose to 55.1, the highest since March 2015, and Japan’s rose to 52.8, the highest since March 2014. The Eurozone’s edged up to 55.1, the best level since April 2011, led by Germany’s (56.5) and France’s (53.4).
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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