Corporate Earnings Check-In
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It's no secret that corporate profit margins have driven earnings higher which in turn, has expanded economic growth and propelled US stocks forward. But since this time last year, we have been wondering aloud whether or not such strong corporate profits were really sustainable. Now that two-thirds of the S&P 500 companies have reported fourth quarter results, let's check in and find out where we are.
Year-over-year earnings growth for the fourth quarter is tracking near 17%. This is solid growth, but below the 25% pace of the prior three quarters (see table below). F
orward-looking guidance however, has been lukewarm, mostly because of the uncertainty around the US/China trade dispute and slower growth overseas.
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It has become clear to us that earnings growth will slow in 2019. The tax reform bill that caused the initial earnings boost will be much less impactful this year, and based on management commentary this quarter, most companies are already feeling the effects of the China trade dispute. Until there is clarity around tariffs, supply chains and business and consumer confidence here and in China, the uncertainty will act as a headwind for corporate America.
Some additional thoughts:
- Earnings Surprises: On the one hand, it's tougher for companies to produce big upside surprises at this late stage in the economic cycle. On the other hand, the bar for 2019 has already been lowered substantially. Consensus estimates for first quarter earnings are nearly flat from a year ago. That sets companies up to surprise on the upside when first quarter results start coming in.
- Economic Fundamentals: Economic growth in the US has slowed, but it remains solid. The strong labor market and rising wages has reaffirmed the strength of the consumer. ISM readings on manufacturing and services signal near term earnings gains and inflation has largely normalized, and it remains manageable.
- Fiscal Stimulus: Fiscal policy remains supportive, and after the Fed took a pause in raising rates, concerns about restrictive monetary policy have settled down considerably. Policy uncertainty has clouded capital investment decisions, but tax reform incentives remain in place, and if a trade deal with China is reached, more business spending may be in the cards.
- Share buybacks: Healthy corporate balance sheets, still-low borrowing costs, and repatriation of overseas profits at low tax rates (part of the December 2017 tax reform) all support another year of robust share buyback activity.
Although the peak earnings growth rate for this economic expansion is almost certainly behind us, profit growth peaks have historically been followed by several years of economic growth and stock market gains, so there may yet be room for stocks to run.
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US Stocks end
ed modestly higher last week on generally favorable economic signals.
Reports on the health of the US service sector indicated solid expansion, and weekly jobless claims fell back significantly.
By midweek, t
he CBOE Volatility Index (VIX) hit a five-month low. Energy stocks lagged last week as oil prices fell, and utilities performed the best.
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Big Tech and the S&P 500
The 4 biggest companies in the S&P 500 right now are tech companies. Even if you go back to the height of the dot-com bubble in 1999, you won't see this degree of tech dominance in the index.
I
nformation technology and the communication services sectors make up 40% of the S&P 500. The four biggest c
ompanies in the index -
Microsoft, Apple, Amazon and Alphabet -
have become central to our lives and are now central to our markets. However, t
ech dominance waxes and wanes. In 1985, IBM was by far the biggest company in America, responsible for over 6% of the S&P 500 on its own. By 1992, there were no tech companies in the top 10 at all.
And, as these businesses face the increasing possibility of regulation, their dominance may not last.
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Financial Conditions
The Goldman Sachs Financial Conditions Index, which tracks changes in interest rates, credit spreads, equity prices and the dollar, tightened considerably in 2018.
What started as gradual tightening last year accelerated in the fourth quarter as equity markets fell and credit spreads moved wider, in part due to the expectation of overly aggressive Fed policy in 2019.
However, the pendulum has now swung the other way as the equity market has rallied, credit spreads have narrowed and the dollar has edged lower. Through much of this rate hiking cycle, the Fed has not had to worry about financial conditions, as solid economic fundamentals and healthy capital markets offset rate rises. However, the reversal of this dynamic has led the Fed to turn more dovish.
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The High Cost of Love
Valentine's Day celebrations are going to cost you. An all-out celebration including chocolate, diamonds, roses, fine-dining and champagne will cost consumers an average of $617.77, according to Bankrate’s 2019 Be My Valentine Index.
The National Retail Federation says participation in Valentine's Day gift giving has been on the decline, but the total amount of money spent continues to rise. Just 51% of Americans plan to celebrate the holiday but the NRF expects them to spend $20.7 billion. That's a 6% increase from last year and breaks the previous record of $19.7 billion spent in 2016.
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