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Tags: earnings | meltup | trump | p-e | meltdown

Earnings Meltup Should Trump Price-Earnings Meltdown

Earnings Meltup Should Trump Price-Earnings Meltdown
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Dr. Edward Yardeni By Tuesday, 13 February 2018 09:07 AM Current | Bio | Archive

Strategy I: Big Deal for Earnings. The S&P 500 peaked at a record high of 2872.87 on January 26. It plunged 10.2% through last Thursday’s close (Fig. 1).

While stock prices swooned, industry analysts continued to raise their earnings estimates for the S&P 500 to reflect the impact of the Tax Cut and Jobs Act (TCJA) passed on December 22 (Fig. 2).

Since then, over the past eight weeks through the week of February 8, they’ve increased their 2018 estimates by $10.62 to $156.88 per share.

Their consensus estimate for 2019 is up $11.60 to $172.67 over the same period. In the past, the weekly “Earnings Squiggles” have had a downward bias, which will probably resurface for 2018 and 2019 once the tax cut is fully reflected in earnings estimates (Fig. 3).

Surprisingly, even the 2018 growth rate in S&P 500 revenues per share on a y/y basis has increased from 5.6% just before TCJA to 6.2% last week (Fig. 4).

In other words, while the stock market had a January meltup followed by a February meltdown, earnings estimates continued to melt up. That was because industry analysts have received very upbeat guidance on the earnings impacts of the TCJA from company managements since Q4 earnings reporting began at the start of this year. The recent divergence between soaring earnings estimates for the S&P 500/400/600 and their plummeting stock price indexes has been remarkable, as shown by our Blue Angels analysis (Fig. 5).

As we have previously noted, it’s not clear why the outlook for revenues growth improved for this year following the passage of TCJA, unless many industry analysts have suddenly turned into supply-side economists believing that lower tax rates will boost economic growth. Of course, the global economic outlook has started to improve since late 2016, and the trade-weighted dollar has been weak over this period. Both factors will boost both revenues and earnings growth rates for the S&P 500. However, both factors have been working to do so for at least a year before TCJA was passed.

Joe and I have been mightily impressed by the boost to earnings from the TCJA. So far, it is turning out to be almost twice what we expected. We believe that the meltup in earnings estimates should limit the recent meltdown in the S&P 500’s forward P/E, which dropped from a recent high of 18.6 on January 26 to a low of 16.3 on February 8 (Fig. 6). Actually, the rapidly rising outlook for earnings should revive valuation multiples, and may have started to do so late last Friday.

In any event, we need to raise our outlook for S&P 500 earnings during 2018 and 2019.

Here’s our latest thinking on the subject:

(1) Baseline assuming no TCJA. For starters, let’s consider the underlying trend in earnings. The trend annual growth rate in S&P 500 reported earnings since 1935 has ranged between 5% and 7% (Fig. 7). In our work, Joe and I give more weight to S&P 500 forward earnings, the time-weighted average of analysts’ consensus earnings estimates for the current year and the coming year. It has fluctuated around a 7% trendline since the late 1970s (Fig. 8).

We estimate that S&P 500 operating earnings per share totaled $132 last year. A 7% growth rate would raise it to $141 in 2018 and $151 in 2019.

(2) Earnings with TCJA. Joe reminds us that the earnings season isn’t over and that the consensus estimate for the impact of TCJA on S&P 500 earnings could rise from $11-$12 currently to $14-$15 once all the companies have reported and provided guidance.

So we are penciling in a 2018 forecast of $155. For next year, based on a 7% growth rate, we are using $166. These are significant upward revisions for us. We don’t think they’ve been reflected in the market, certainly not during the recent correction. Indeed, the consensus 2018 estimate of the 10 investment strategists (including yours truly) surveyed last year in the 12/9 Barron’s was $145.

(3) Reconciling us with them. The latest 2018 and 2019 analysts’ consensus estimates are even higher than our latest forecasts. Analysts tend to be too optimistic about the future prospects for their companies. That’s why there is usually a downward drift in their estimates for both the level and the growth of earnings as they converge to actual results (Fig. 9 and Fig. 10).

Analysts are currently projecting $156.88 for 2018 and $172.67 for 2019. Once they’ve all incorporated the impact of TCJA on their companies by the end of the current earnings season, the downward drift should begin. Their 2018 numbers should decline toward our current estimate as the year progresses, assuming we are on target. In any case, all of our estimates will converge to the actual results by the end of this year.

However, the analysts’ 2019 estimate, which should soon start drifting lower, may very well still exceed our forecast for 2019 at the end of this year. It is their estimate that will be discounted in the market, not ours. That’s based on our view that the market discounts forward earnings, which will be the same as analysts’ consensus expectations for 2019 at the end of this year. (We hope you are still following our drift on all of this!)

Strategy II: Big Tailwind for Stocks. Now the fun begins in earnest: What does the outlook for earnings imply for the S&P 500 stock price index by the end of the year? The bottom line is that we are sticking with our forecast of 3100, which would be a 16.7% increase from yesterday’s close. Our target is based on our 2019 earnings estimate of $166 multiplied by a forward P/E of 18.7. Our earnings outlook provides a big tailwind for this bullish forecast.

If the P/E seems high, particularly after the recent P/E meltdown from 18.6 on January 26 to a low of 16.3 on February 8, keep in mind that the market will probably be discounting the analysts’ 2019 forecast at the end of this year, which is likely to be higher than our estimate.

Strategy III: Lots of Upbeat Earnings Indicators. While valuation multiples have swooned during the latest correction, earnings indicators have been uniformly bullish. Above, Joe and I reviewed the major ones. There are plenty more. Consider the following:

(1) Revenues. S&P 500/600/400 forward revenues are all on uptrends in record-high territory (Fig. 11). Looking at the 2018 revenue forecast, they are up 1.3%, 0.4%, and 0.2%, respectively. Only the S&P 500 revenues series seems to have gotten a TCJA boost.

(2) Profit margins. S&P 500/400/600 forward profit margins have all gotten big TCJA boosts (Fig. 12).

(3) Quarterly earnings estimates. There has been a typical earnings season upside hook for Q4-2017, with the actual growth rate at 14.8% y/y, up from the 11.4% increase expected just before the latest season started. That’s nothing compared to the upward revisions in the y/y growth rates now expected for each of this year’s four quarters for the S&P 500/400/600. All 12 of these growth rates are expected to be in the double digits this year (Fig. 13 and Fig. 14).

Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.

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Analysts now saying TCJA adding $11-$12 per share to S&P 500 earnings this year.
earnings, meltup, trump, p-e, meltdown
Tuesday, 13 February 2018 09:07 AM
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