Earnings Do Matter and can be Engines of Stock Market Growth
At Hennion & Walsh, we believe that the prospects for continued economic growth, assisted by certain improved equity market valuations, have formed the basis of a “new bull market” and should be supportive of higher equity prices. While additional short term bouts of volatility can be expected, this new bull market will likely be driven by earnings growth and economic expansion. As a result, we continue to pay particular attention to corporate earnings.
With the passage of the tax act earlier this year, we anticipate that corporate earnings will further be bolstered in the quarters ahead by the lowering of the corporate tax rate from 35% to 21%.
As we head into the thick of earnings season for the third quarter of 2018, on top of strong 1st quarter and 2nd quarter 2018 earnings seasons, FactSet estimated on October 5, 2018 that the earnings growth rate for the S&P 500 will be 19.2% for the 3rd quarter. If earnings do register 19.2% for the quarter, it would mark the third highest earnings growth rate since the 1st quarter of 2011. However, if 3rd quarter earnings do ultimately come in above the 20% growth mark, it would represent the third consecutive quarter of 20% earnings growth.
In addition, as of October 5, 2018, 21 companies within the S&P 500 Index had reported third quarter earnings and 86% have of them reported a positive earnings-per-share (EPS) surprise while 71% of these same companies reported a positive sales surprise. Finally, the blended net profit margin for the S&P 500 for the third quarter of 2018 is currently 11.6% and if 11.6% is the actual net profit margin for the quarter, it will mark a tie for the second highest net profit margin for the S&P 500 since FactSet began tracking this data back in 2008. All are encouraging statistics for both the economy and stock market, albeit from a small sample size.
Below are some “beats”, “matches” and ”misses” from earnings reports for the 3rd quarter of 2018, across multiple sectors, which have been released thus far according to Yahoo! Finance.
Costco Wholesale Corp. (GICS Sector: Consumer Staples)
Costco “matched” with reported 3rd quarter earnings per share (EPS) of 2.36 vs. an EPS estimate of 2.36.
PepsiCo Inc. (GICS Sector: Consumer Stapes)
Pepsi “beat” with reported 3rd quarter earnings per share (EPS) of 1.59 vs. an EPS estimate of 1.57.
Fastenal Co. (GICS Sector: Industrials)
Fastenal, a distributer of industrial and construction supplies, “beat” with reported 3rd quarter earnings per share (EPS) of 0.69 vs. an EPS estimate of 0.67.
Delta Air Lines Inc. (GICS Sector: Industrials)
Delta “beat” with reported 3rd quarter earnings per share (EPS) of 1.83 vs. an EPS estimate of 1.74.
Commerce Bancshares Inc. (GICS Sector: Financials)
Commerce “beat” with reported 3rd quarter earnings per share (EPS) of 1.03 vs. an EPS estimate of 0.96.
JP Morgan Chase & Co. (GICS Sector: Financials)
JP Morgan “beat” with reported 3rd quarter earnings per share (EPS) of 2.34 vs. an EPS estimate of 2.25.
Wells Fargo & Co. (GICS Sector: Financials)
Wells Fargo narrowly “missed” with reported 3rd quarter earnings per share (EPS) of 1.16 vs. an EPS estimate of 1.17.
Citigroup (GICS Sector: Financials)
Citigroup “beat” with reported 3rd quarter earnings per share (EPS) of 1.73 vs. an EPS estimate of 1.69.
International Business Machines Corp (GICS Sector: Information Technology)
IBM did “beat” with reported 3rd quarter earnings per share (EPS) of 3.42 vs. an EPS estimate of 3.4, but revenue fell short of expectations by registering $18.76 billion for the quarter vs. estimates of $19.10 billion.
Netflix (GICS Sector: Communication Services)
Netflix, the internet subscription service for watching television shows and movies, posted a strong “beat” with reported 3rd quarter earnings per share (EPS) of 0.89 vs. an EPS estimate of 0.68.
Johnson & Johnson (GICS Sector: Health Care)
J&J “beat” with reported 3rd quarter earnings per share (EPS) of 2.05 vs. an EPS estimate of 2.03.
Prologis Inc. (GICS Sector: Real Estate)
Prologis, an owner, operator and developer of industrial real estate, “beat” with reported 3rd quarter earnings per share (EPS) of 0.60 vs. an EPS estimate of 0.35.
Please note: Data sourced from Bloomberg as of August, 23 2018. Current P/E is the ratio of a stock and the company’s earnings per share and is calculated as the stock’s price divided by trailing twelve month earnings per share (EPS). Forward P/E is calculated by dividing the price of a security by Bloomberg estimates of earnings per shares, looking at consensus estimates for the next four quarters. You cannot invest directly in an index. Past performance is not an indication of future results.
Global Economic Growth Forecasts
Economic growth, as measured by gross domestic product (GDP), has been robust in the U.S. thus far in 2018. This may be beneficial for international equities looking ahead as international economic cycles have typically lagged U.S. economic cycles by 1 – 3 years according to a Buffalo Funds research report published in August 2018 entitled, “The Case for Investing Internationally.” Additionally, according to this same report, GDP is actually growing faster in certain regions outside the U.S. and is projected to continue to outpace U.S. growth.
Central Bank Policies
In the U.S., the Federal Reserve has embarked upon a gradual and extended period of tightening that will continue to involve some combination of interest rate hikes and balance sheet reductions. With respect to interest rate hikes, as it stands now, we believe that the Fed will likely raise the Federal Funds Target Rate one more time this year and three additional times in 2019 as they address potential mounting inflationary concerns. This stands in contrast to many other central banks across the globe who will likely continue to pursue their own accommodative monetary policies by either maintaining current interest rate levels or perhaps even cutting their respective interest rates. This type of accommodative environment often helps to spur economic growth, which historically has been beneficial to upside stock price potential.
With these driving factors understood, there are still many potential risks and uncertainties as it relates to international equities that may continue to provide volatility inducing headwinds. These risks and uncertainties include, but are not limited to, on-going trade agreement tensions (Ex. U.S. and China), unrest in certain Emerging Market countries (such as Turkey and Venezuela) and fluctuating currency exchange rates. Despite these uncertainties, we see attractive investment opportunities for international equities looking ahead. While we could certainly also make a bullish case for U.S. equities over the short-intermediate term, selectively including international equities with U.S. equities in a global equities portfolio strategy, where appropriate, seems worthy of consideration.
Disclosure: Hennion & Walsh Asset Management currently has allocations within its managed money program and Hennion & Walsh currently has allocations within certain SmartTrust® Unit Investment Trusts (UITs) consistent with several of the portfolio management ideas for consideration cited above.