Strategy: Trump’s Pick-Me-Up.
President Donald Trump doesn’t drink alcohol. He is a teetotaler. He has raised his five children to be the same. He wants them to abstain from drinking liquor, and also from taking drugs. His pick-me-up seems to be tweeting. When he feels down after someone attacks him, he sends a tweet.
The stock market has had very few down days and many record-setting up days thanks to Trump’s indulgence in deregulation and tax cuts.
Joe and I estimate that without the corporate tax cut enacted at the end of last year, S&P 500 operating earnings per share would have been $141.00 this year, up 7.2% from last year. We estimate that the tax cut will boost earnings by $6.00, putting this year’s earnings at $147.00, up 11.8%. Earnings growth should resume its trend growth of roughly 7% next year, rising to $157.50 (Fig. 1). (See YRI S&P 500 Earnings Forecasts.)
Since the end of 2017, when the S&P 500 closed the year at 2673.61, our target for the index has been 3100. That would be a 15.9% increase (Fig. 2). The index closed at 2839.13 yesterday, so our year-end target implies a 9.2% increase in the S&P 500 over the rest of this year.
Our forecasts for the S&P 500 and its earnings for 2019 imply that the forward P/E will increase from 18.6 on Monday to 19.7 at the end of this year (Fig. 3). Now let’s see how our numbers compare to the consensus of industry analysts.
The bottom line is that they are guzzling Trump’s tax-cutting punch:
(1) Annual earnings estimates for 2018 and 2019. Since the week of December 15, 2017 through the week ending January 19, consensus expected S&P 500 earnings has increased $5.50 per share for the current year to $151.76 (Fig. 4). That raises the consensus growth rate for this year from 11.5% then to 15.7% now (Fig. 5). The estimate for 2019 is currently up 10.4% from 2018.
Why the big discrepancy between our estimates and the consensus ones? Industry analysts tend to be too optimistic and lower their estimates over time as they approach reporting seasons. Once they’ve incorporated the tax cuts into their spreadsheets, they are likely to shed some of their optimism. This pattern is very visible in our tracking of monthly earnings expectations for every year since 1980 (Fig. 6 and Fig. 7). From 1980 to 2017, there have been 38 “Earnings Squiggles” with 30 (79%) of them having endpoints below their starting points. The up-year exceptions were 1980, 1988, 1995, 2004, 2005, 2006, 2010, and 2011.
(2) Quarterly estimates for 2018. Consensus earnings estimates are also up sharply since December 15, 2017 (Fig. 8). Here are the Q1-Q4 upward revisions: $1.29, $1.41, $1.41, and $1.46. The y/y growth rates are now 14.9% for Q1, 15.1% for Q2, 16.3% for Q3, and 14.6% for Q4 (Fig. 9).
(3) Forward earnings flying. S&P 500 forward earnings jumped 4.8% over the past five weeks to a record $152.66 per share (Fig. 10). The forward earnings of the S&P 400 and S&P 600 are also up at record highs, rising 4.5% and 5.6%, respectively, over the same period.
(4) Forward revenues and profit margins at new highs. The forward revenues of the S&P 500/400/600 remain in uptrends in record-high territories (Fig. 11). While Trump’s tax cuts may boost economic growth, there’s no sign that analysts are significantly raising their revenues projections. They’ve been bullish on revenues since early 2016 when forward revenues estimates resumed their climbs to fresh record highs after stalling during 2015. Their bullishness on revenues has been fueled by mounting evidence of a global synchronized expansion, which has become increasingly visible since mid-2016.
With forward earnings estimates outpacing revenues estimates, the forward profit margins of the S&P 500/400/600 have gone vertical since late last year (Fig. 12). This margin is at a record 11.5% for the S&P 500.
(5) Off the charts. The practical problem we are having at YRI is keeping our charting system working properly. The charts are automatically updated, but the system doesn’t have a feature that resets the left and right scales when a data series goes off the chart. We have to do that manually once we’ve detected the problem. It’s a good problem to have when stock prices are going off the charts, confirming our bullish stance.
For example, in our Blue Angels analysis of the S&P 500/400/600, we’ve had to make headroom for all three, and we’ve added implied stock price series using valuation multiples of 20x forward earnings for the S&P 500/400 and 22x for the S&P 600 (Fig. 13). This analytical construct shows quite clearly that the recent ascent in stock prices has been earnings-led more than P/E-led. However, we are making room for more P/E expansion on top of the post-TCJA (Tax Cuts and Jobs Act) surge in forward earnings.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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