Earnings update: Raising the bar
by Burt White, CIO, LPL Research
• First quarter earnings season has been excellent by almost any measure.
• The comparison to depressed first quarter 2016 earnings was very easy, so the bar will be raised over the next several quarters.
• Market participants generally expect fiscal policy to begin to provide an earnings boost around New Year’s, an expectation that has become increasingly tenuous.
We continue to expect earnings may provide support for stocks in the months ahead.
Excellent earnings season but bar will soon be raised. First quarter earnings season has been excellent by almost any measure. Results beat expectations by more than usual. The overall growth rate is very strong, even without the big boost from energy. The ratio of companies lowering versus raising second (current) quarter earnings forecasts is well above average and guidance has provided better-than-usual support for analysts’ estimates for the balance of 2017. In total, these are all good things.
While we do not want to rain on the well-deserved earnings parade, two potential headwinds are worth noting. One, the comparison to depressed first quarter 2016 earnings was very easy and the bar will be raised over the next several quarters. Two, market participants generally expect fiscal policy to begin to provide an earnings boost around New Year’s, an expectation that has become increasingly tenuous as healthcare reform, other competing priorities, and various distractions have pushed the timetable back.[SIDEBAR] Different sources such as FactSet, Bloomberg, Standard & Poor’s and others have different calculations than Thomson Reuters for S&P 500 earnings, based on various methodologies and different interpretations of what constitutes operating earnings. We favor Thomson Reuters and FactSet for their long track records and wide followings.
Excellent earnings season by almost any measure
First quarter earnings season has been excellent by many measures. S&P 500 earnings are tracking to a nearly 15% year-over-year increase (Thomson Reuters), the best since the third quarter of 2011[Figure 1]. Despite easy comparisons against the trough of the earnings recession one year ago, we continue to be impressed with corporate America’s ability to maintain high levels of profitability despite pressures of slow economic growth, volatile commodities prices, and rising wages. Earnings have been an underrated driver of the stock market’s recent success—the S&P 500 is up 14% since the earnings recession effectively ended on July 1, 2016, compared with just 4% during the 12-month-long earnings recession from mid-2015 through mid-2016.
Despite the substantial hit to energy sector profits since oil peaked in late 2014, S&P 500 operating margins are just 1% off all-time highs reached in December 2014 (FactSet data). S&P 500 operating margins were two percentage points higher in 2016 than in 2006, and, based on consensus estimates, are expected to add another percentage point in 2017 and possibly another half point in 2018. Those estimates (based on analysts’ consensus) could prove optimistic, but the combination of stellar profitability and strong revenue growth (over 7% year over year in the first quarter), has enabled S&P 500 companies to produce double-digit earnings growth for the first time since the third quarter of 2014.