First quarter earnings season, which kicks off April 12–13, sets up to show solid growth, buoyed by tax reform. The S&P 500 Index has grown earnings at a double-digit clip in three out of the past four quarters, a trend that is poised to continue for the first quarter. The index could also extend its streak of 35-straight quarters of exceeding earnings expectations. In this week’s commentary, we preview what we expect may be a very strong earnings season and highlight some key dynamics we will be watching.
Another Strong earnings Season On Tap
We expect a year-over-year increase in earnings for the S&P 500 in the 20% range for the quarter, based on consensus estimates and the average upside to estimates historically, a nice acceleration from the fourth quarter. Reasons for optimism include:
– Continued solid U.S. and overseas economic growth. Revenue and gross domestic product (GDP) are correlated, which bodes well for S&P 500 revenue which is expected to increase over 7%. U.S. economic growth, according to Bloomberg consensus, is expected to increase 2.8% year over year for the first quarter, which is a good pace for this environment. Growth remains generally solid around the world, although economic growth has slowed some in Europe and Japan.
– New tax law. Earnings estimates for the first quarter have increased by about 6% so far this year, due almost entirely to the Tax Cuts and Jobs Act. The increase was the biggest ever (according to data from Ned Davis Research) and is about 10% better than the average quarterly change of a 3–4% decline. The reduction in the corporate tax rate is the biggest factor; however, individual tax cuts, incentives to encourage capital investment, and repatriation of overseas cash could have driven some of the increase as well (and may offer the potential for a future boost). The increase in estimates, the favorable pre-announcement trend, and ongoing benefits of the tax law all point to solid results.
– Robust manufacturing activity. The U.S. manufacturing sector is closely linked to earnings, so the signal from the booming Institute for Supply Management (ISM) Manufacturing Index survey is noteworthy. At an average near 60 during the first quarter, this reading indicates manufacturing is as strong as it has been since before the 2008–2009 financial crisis.
– Weak U.S. dollar. During the first quarter, the average U.S. Dollar Index level was more than 10% below the year-ago quarter. Dollar weakness props up overseas earnings for U.S.-based multinationals and could present a strong tailwind for first quarter earnings—potentially in the 2–3% range.
Roughly one third of S&P 500 companies’ revenue is earned outside of the United States, which makes currency fluctuations (and U.S. trade policy) a big deal for corporate profitability.
Earnings gains are expected to be particularly strong in the energy, financials, and technology sectors, though we believe growth will be broad-based. Based on consensus estimates, we could see positive earnings growth in all 11 sectors.