Strategy I: Revenues Estimates Are Hot.
The industry analysts covering the S&P 500 companies are high on life or something else. Their consensus expectation for the composite’s 2018 revenues per share has increased to a new record high at the end of April, up 3.4% since the first week of September 2017 (Fig. 1).
Over the same period, their estimate for 2019 revenues has risen by 3.2%. They now expect that revenues will be up 7.4% this year and 4.7% next year (Fig. 2). Joe and I doubt that Trump’s tax cuts at the end of last year converted analysts into supply-side believers.
More likely is that companies are telling analysts that global economic growth is improving.
Let’s dive into revenues expectations for the individual S&P 500 sectors to see what’s been driving the aggregate expectation skyward (Fig. 3).
(1) 2018 revenues. We can see that much of the strength in revenues is spread across the cyclical sectors. Focusing on the percentage increases in 2018 expected revenues per share since the first week of September, here’s the performance derby: Energy (11.7%), Health Care (10.0), Tech (4.5), Materials (4.3), Real Estate (3.7), Industrials (3.6), S&P 500 (3.4), Consumer Discretionary (3.0), Financials (2.8), Telecom (0.0), Utilities (-4.2), and Consumer Staples (-7.9).
(2) 2019 revenues. A similar exercise for the percentage increases in 2019 expectations shows the following: Health Care (9.8%), Energy (6.5), Tech (6.0), Materials (4.3), Industrials (4.1), Real Estate (3.8), Consumer Discretionary (3.3), S&P 500 (3.2), Financials (3.1), Telecom (0.6), Utilities (-3.6), and Consumer Staples (-8.0).
(3) 2018/2017 revenues growth. Here is the latest derby for the consensus projected revenues growth rates in 2018 over 2017: Energy (16.6%), Tech (11.8), Real Estate (9.0), Materials (8.9), Consumer Discretionary (7.6), S&P 500 (7.4), Industrials (7.1), Health Care (5.8), Consumer Staples (4.3), Financials (4.0), Telecom (1.3), and Utilities (1.1).
(4) 2019/2018 revenues growth. Here is the latest derby for the consensus projected revenues growth rates in 2019 over 2018: Tech (7.2%), Consumer Discretionary (5.9), Health Care (5.3), Industrials (4.8), S&P 500 (4.7), Financials (4.6), Consumer Staples (3.8), Utilities (3.0), Materials (2.5), Energy (1.5), and Telecom (0.6).
Strategy II: Earnings Estimates Are Going Vertical. Consensus expectations for the S&P 500 companies’ 2018 earnings per share soared by $11.05 from the week of December 14, 2017—which was just prior to the enactment of Trump’s tax cuts—through the week of February 15, 2018 (Fig. 4).
That period roughly aligned with the earnings reporting season for Q4-2017, before the tax cuts were actually implemented—i.e., nothing about those results would have reflected beneficial tax reform impacts. However, analysts gleaned enough guidance form the giddiness of corporate managements on Q4 earnings calls to jack up their 2018 estimates dramatically. Now that the Q1-2018 earnings season is well underway, estimates are ratcheting to new highs.
Let’s have a closer look at what is going on with consensus earnings expectations:
(1) Q1-2018 earnings flying high. During the previous earnings season (for Q4-2017), earnings estimates for all four quarters of 2018 rose almost in lockstep (Fig. 5). During the current earnings season, the Q1-2018 estimate has been revised higher, while expectations for the remaining three quarters of the year have been remarkably flat.
Frankly, we are puzzled this is happening. It suggests that while Q1-2018 results are surprising analysts to the upside, corporations are guiding analysts to be more cautious about how much better they can perform over the rest of this year. In any case, the blend of actual and estimated Q1 earnings is up $1.76 since the start of the current earnings season, and up $3.72 since Trump’s tax cut was enacted. That’s YUGE!
(2) 2018 and 2019 estimates edge up to record highs. As a result, the estimate for all of 2018 edged up to a record high of $160.14 during the week of May 3 (Fig. 6). By the way, the estimate for 2019 also edged up, to $175.48.
(3) 2018 growth rate rocketing. Just before Trump’s tax cut, industry analysts were projecting earnings growth of 11.2% this year (Fig. 7). Now they are projecting 21.3%! On the other hand, their earnings growth estimate for 2019 edged down to 9.7%.
(4) Us vs them. We would like to try some of whatever the analysts are smoking. You can compare our earnings forecasts to their consensus estimates on a weekly basis in YRI S&P 500 Earnings Forecast on our website. We say “tomato.” They say “tomahto.”
Our estimate for 2018 is $155.00 (up 17.4% y/y). The analysts continue to up the ante and are currently at $160.14 (up 21.3%), as noted above. Our estimate for 2019 is $166.00 (up 7.1%). Theirs is $175.48 (up 9.6%).
They could be right about 2018, especially since they just boosted their Q1-2018 sights based on results reported so far during the earnings season. At the same time, they have been conservative on the remaining quarters of this year. Next year’s growth estimate seems too high to us since we expect it to settle back down to the historical trend of 7%.
(5) Profit margins exploring outer space. Joe and I calculate the operating profit margin of the S&P 500 on a weekly basis, dividing analysts’ earnings estimate by their revenues estimate for the composite’s companies (Fig. 8).
Their (thusly derived) 2018 estimate for this margin jumped from 11.1% the week before Trump’s tax-cutting bill was enacted late last year to 11.9% in early May. Their 2019 estimate jumped from 11.7% to 12.5% over this same period. The forward profit margin, which is the time-weighted average of the two, rose to a record 12.2% from 11.1%.
Granted, the forward profit margin has always been higher than the actual margin based on S&P data for operating earnings (Fig. 9). But the trends have been the same.
Odds are that the profit margin windfall will be eroded if companies respond to it by spending more on labor and capital. With the unemployment rate just below 4.0%, labor costs could put some upward pressure on margins. Furthermore, Trump’s tax cuts included allowing companies to depreciate their entire outlays on capital spending during the year in which they were incurred rather than over several years. That should provide a significant boost to capital spending, which would also lower the profit margin. Then again, corporations are likely to continue buying back their shares, which wouldn’t affect their margins but would increase their earnings and revenues on a per-share basis.
Strategy III: Stock Market Equation. You can drive a truck between our earnings estimates and theirs. However, they both suggest that the stock market is likely to be at new record highs by the end of this year. As the year progresses, the earnings estimate for this year will be less relevant, while the estimate for 2019 will be more so. By the end of the year, the market will be discounting analysts’ consensus earnings estimate for 2019, not our estimate.
However, analysts tend to be too optimistic and often lower their estimates as earnings seasons approach. So let’s split the difference between our estimate and their current estimate for 2019. That would put consensus earnings for 2019 at $170 per share by the end of this year. Now let’s apply forward P/Es of 14, 16, 18, and 20 to estimate where the S&P 500 will be at year-end:
2380 (down 12.7% from Friday’s close)
2720 (down 0.3%)
3060 (up 12.2%)
3400 (up 24.6%)
We pick the third scenario. Our year-end target for the S&P 500 remains 3100. In our scenario, inflation remains subdued around 2.0% for the foreseeable future. Real GDP grows between 2.5%-3.0% this year. The Fed raises the federal funds rate to 2.25%-2.50% by the end of the year. The 10-year Treasury bond yield trades between 3.00% and 3.50% over the rest of the year. Investors conclude that interest rates aren’t likely to move much higher in 2019 and increasingly believe that the economic expansion might last beyond July 2019, when it will be the longest one on record. (YRI Economic Forecasts is always posted on our website.)
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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