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Will US Earnings Catch Up?
BY SAM GREEN - 20/04/2017 | VIEW MORE ARTICLES BY TRADERS CIRCLE

Since the US presidential election in November, the US S&P 500 index of America’s largest companies is up by over 12%. The Dow 30 is up by more than 14%.

Whilst some have attributed the rise to investors responding positively to Trump’s policy proposals, the reality is that a combination of factors have conspired to lead US markets higher.

Notably, we have seen something of a rotation from bonds to stocks over the past few months. Bond prices are inversely correlated with interest rates, and with US interest rates rising, bond prices have started falling. This negative outlook on bonds has likely seen some investors cash out of bonds and back into stocks, helping the post-electoral rally.

However, many investors remain bearish on the future of US interest rates, and some believe that talk of a “Great Rotation” out of stocks and into bonds is overdone. "Despite a sharp rise in interest rates during the past six months and a drop in the market value of debt holdings, we expect minimal asset rotation away from debt and into equities during 2017" David Kostin, chief U.S. equity strategist at Goldman Sachs, said in a report for clients.

Rather, it seems the rally has also been driven by the increasingly profitability of US stocks. In fact, S&P500 earnings are forecast to have grown by around 10% in the first quarter of 2017; the strongest growth since Q4 2011.

Do not be surprised to see earnings grow by even more than 10%; earnings forecasts tend to be lowered in the lead-up to reporting season, and almost always underestimate companies’ profitability. In any given season, around 70% of S&P 500 companies likely to exceed their final earnings forecasts.

The largest contribution to the S&P 500 profit growth will come from the energy sector, which has benefitted immensely from rising oil prices. The sector is expected to report earnings of $US7.5 billion in Q1 2017, a rise of $US9 billion from the loss of $US1.5 billion that the sector reported in Q1 2016.

Strength was also seen in the Financial, Information Technology, and Materials sectors, whilst the Industrial sector declined, in large part to declining airline earnings; which have weakened due to the strength in energy prices.

Analysts are expecting a strong year for US company earnings, with 2017 earnings and revenues for S&P 500 companies expected to rise in each quarter of the year. It is worth noting that this performance appears to already be incorporated in to prices. The 12-month forward price-to-earnings ratio for the S&P 500 is currently 17.4. This means that each share price is 17.4 times what that company will earn this year. This P/E is well above both the 5-year and 10-year averages of 15.1 and 14.0 respectively.

The implication here is that even if the current earnings forecasts are not lowered, and are achieved, US share prices are still historically expensive.




View More Articles By Traders Circle

TradersCircle is one of Australia's leading stock market education firms, and runs one of the country's busiest options trading desks. Learn more at www.traderscircle.com.au.


 

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