John Lynch Chief Investment Strategist, LPL Financial
Second quarter earnings season is underway and may be another good one. Consensus estimates are calling for a 21% year-over-year increase in S&P 500 Index earnings for the quarter, setting up a second straight quarter of 20% or higher growth and marking the eighth straight quarterly increase. Should results come in ahead of expectations as we expect, our data indicate it would mark the 37th consecutive quarter of earnings exceeding expectations. While tariffs have dominated headlines recently, and some companies are being disproportionately affected, we do not expect trade tensions to have much impact on overall results. The season kicks into high gear this week (July 23–27) with 175 S&P 500 companies reporting.
KEY EARNINGS DRIVERS
We expect several factors to drive S&P 500 earnings growth over 20% during the second quarter:
- Corporate and individual tax cuts. Corporate tax cuts have lifted S&P 500 Index profits by about 7%. Consumer spending may also be getting a boost from individual tax cuts that began to kick in this spring.
- Strong manufacturing activity. The Institute for Supply Management (ISM) Manufacturing Purchasing Managers’ Index (PMI) came in at a very strong 60.2 in June and has averaged over 59 so far in 2018, in line with the best readings over the past 30 years. Manufacturing activity has historically correlated well with earnings.
- Higher oil prices. The average price of WTI Crude in the second quarter of 2018 was 36% above that of the prior year quarter. Higher gas prices do hit consumers’ wallets, but with a lag. Energy production is a much bigger driver of S&P 500 profits than prices at the pump.
- Lower U.S. dollar. Although the U.S. dollar rose during the second quarter of 2018, the average price of the U.S. Dollar Index during the quarter was 6% lower than a year ago. As a result, the year-over-year earnings growth figures will get a point or so boost from currency this season because of the overseas profits generated by U.S.-based multinationals.
We expect modest upside to current estimates based on historical patterns. Upside in line with the long-term average would put growth in the 24% range. The +0.9% revision to second quarter earnings estimates during the quarter and above-average ratio of positive-to-negative preannouncements (0.74) are positive signs. A solid 84% of the 87 S&P 500 companies that have reported thus far have exceeded earnings estimates, well above the long-term average.
At the sector level, the biggest drivers of the strong year-over-year increase are expected to be technology, energy, and financials (in that order). In fact, more than 60% of the earnings growth is expected to come from those three sectors based on consensus estimates. Energy is expected to produce the strongest growth again, bolstered by the sharp rise in oil prices over the past year. Technology and financials are also expected to see strong earnings gains, both driven by lower taxes and strong revenue growth. Internet software & services and semiconductors are expected to see the biggest increases within technology, while financials sector earnings are benefiting from a better trading environment, higher interest rates, and deregulation.
Industrials will be a key sector to watch this season given its exposure to tariffs and trade tensions. Estimates for the sector’s earnings were revised slightly lower during the second quarter, but the sector’s earnings growth is still expected to approach 20% for the quarter after all results are in, which would likely place it in the top half of all S&P 500 sectors. The story for materials is the same, where more than 30% earnings growth is expected but tariffs may bite. A leading materials company blamed tariffs for its lowered profit outlook last week.