While investors worry about trade wars, inflation and interest rates, corporate America just keeps on making money.
In fact, profits for the first quarter are expected to run at the highest rate in seven years as companies begin to reap the benefits of tax breaks, improving consumer confidence and a growing economy.
The projections are eye-popping: a 17.2 percent growth rate in bottom-line profit for the S&P 500 — the best since the first quarter of 2011 — coupled with solid top-line sales gains of 7.2 percent, according to FactSet. More than 50 companies already have revised their guidance upward, a record since FactSet started keeping track in mid-2006.
That’s all good news.
So what’s the downside?
The bad news is that this may be as good as it gets, with a strong earnings season only confirming what investors already knew and providing little upside tailwinds for stocks.
“This is good for the market in terms of confirming what the market already has priced in for equity prices,” said Michael Yoshikami, founder of Destination Wealth Management. “Is it going to make the market go higher? That’s questionable.”
That’s in part because the market already has gone considerably higher.
Last year’s robust 20 percent gain in the S&P 500 was predicated in large part on expectations that a sharp corporate tax reduction would drive earnings. But with that forward-looking trade in the rear view, gains ahead should be tougher to come by.
“What’s really boosting earnings this late in the cycle is the new tax law. So what are we going to do for an encore?” said Mitchell Goldberg, president of ClientFirst Strategy. “Even if we have the same really strong earnings and revenues in 2019 as in 2018, it doesn’t mean growth, and growth ultimately is what’s going to drive stocks higher and multiples higher at this point.”
Indeed, such a strong propulsion in 2018 will make comps harder in the year ahead, presenting another challenge for a market that has grown suddenly volatile.
The outlook appears formidable: 19.1 percent earnings growth in Q2, 20.8 percent in Q3 and 17 percent in Q4, for a full-year growth rate of 18.4 percent on sales gains of 6.6 percent, according to FactSet. Earnings rose 11 percent in 2017 with a 6.4 percent gain in revenue.
Moreover, if history holds, the 17.2 percent for the first quarter is probably a low-ball estimate.
Analysts usually reduce their forecasts as earnings season gets closer, but the opposite actually has been true this year: Expectations for the quarter were at just 11.3 percent as recently as Dec. 31. Also, exactly half the 104 companies that have adjusted guidance have raised their expectations; that total of 52 companies would be the highest in the 12-year history of FactSet keeping track of the metric.
Bank of America Merrill Lynch expects earnings growth this year to exceed estimates by 1 percentage point, which would be well below the historical average of around 4 points.
Still, hopes that profit strength will help quell market volatility may be ill-founded.
“Despite earnings being the highest they’ve been in years, I don’t think it in any way reduces the potential for the markets to have huge fluctuations in either direction,” Yoshikami said. “Earnings may confirm that the economy is reasonably strong, but it doesn’t change all the uncertainty relative to trade issues as well as the usual geopolitical concerns. This does absolutely nothing to quell the volatility.”
Goldberg said he is moving toward more defensive positions, not just in sectors associated with that kind of strategy but also toward cash and equivalents like money market accounts. However, he remains strongly allocated to stocks, just not as much as before.
“My sense is that it pays to be more defensive going forward, not just in terms of being a little heavier in defensive sectors but in terms of actually taking some chips off the table,” he said. “I don’t see as much growth potential, because we’re probably at peak earnings.”
