John Lynch Chief Investment Strategist, LPL Financial
It’s early in the season, but with about 50 companies having reported fourth quarter results, S&P 500 Index earnings are tracking a 12% yearover-year increase [Figure 1]. A solid 79% of the companies have bested earnings estimates, while 87% have topped revenue targets, both well above recent and long-term averages. In this week’s commentary, we preview fourth quarter earnings season and reiterate our optimism for corporate profits in 2018.
Six Reasons for Optimism
The S&P 500 has exceeded quarterly earnings expectations for 34 straight quarters and we see no reason why the fourth quarter of 2017 won’t make it 35. We believe an increase in the 14–16% range may be achievable, based on a 3–4% average upside to estimates historically. Though earnings growth may be driven mostly by technology and energy, growth is expected to be broad based, with a reasonable chance that all 11 sectors will report growth in earnings when all results are in. Even excluding the sharp rebound in energy sector profits, and despite tougher comparisons against improving late-2016 earnings, a double-digit gain in S&P 500 earnings appears likely.
Here are the six primary reasons why we expect another good earnings season this quarter, relative to expectations:
1. Economic surprises: The U.S. Citi Economic Surprise Index, a measure of economic data relative to expectations, is near record highs. When economic activity surprises to the upside, as it has consistently done in recent months, companies tend to beat estimates. Global economic surprises are also strongly positive, supporting multinationals’ earnings. This unexpected tailwind, combined with management teams’ tendency to be conservative and the lack of negative macroeconomic surprises, points to good upcoming results.
2. Strong manufacturing activity: Manufacturing surveys (such as the Institute for Supply Management’s [ISM] Purchasing Managers’ Index) have historically been well correlated with earnings growth. That means the strong and generally rising global manufacturing indexes are a positive indicator for upcoming earnings reports. The U.S. ISM Manufacturing Index has been above 58 for five straight months, which is strongly expansionary. As with economic surprises, this is not just a U.S. story; manufacturing activity has picked up steam recently in Europe, Japan, and China too.
3. Weak U.S. dollar: During the fourth quarter of 2017, the U.S. Dollar Index fell about 6% year over year, based on average prices. Dollar weakness props up overseas earnings for U.S.-based multinationals and could present a tailwind for fourth quarter earnings given that roughly one third of S&P 500 companies’ revenue is earned outside of the United States.
4. Pre-announcements: The ratio of negative to positive pre-announcements for the fourth quarter, at 1.6, is as favorable as it has been throughout the entire economic expansion. Though in line with last quarter, this ratio is better than the year-ago quarter (1.9) and the long-term average (2.8). Fewer negative profit warnings have historically led to better-thanexpected earnings results.