Earnings, Not Donald Trump, Are Stocks’ Best Friend in 2017
Continued rebound in corporate profits should prop up share prices regardless of Washington policies
Here’s one simple thing set to help sustain stocks’ march in 2017: corporate earnings.
While Donald Trump’s election supercharged investors’ hopes for business-friendly policies, corporate earnings quietly climbed out of a five-quarter slump.
It’s a long-awaited improvement. Stock performance was tepid in 2015 and early 2016, with many investors and analysts citing the lack of earnings growth as a main culprit. The S&P 500 gained 1.9% from the end of 2014 through the first half of 2016.
The 6.7% rally since then, much of it since Election Day, has largely been attributed to the potential for tax cuts, looser regulation and fiscal spending under the president-elect. But the rise has also coincided with a fundamental improvement: U.S. companies’ return to earnings growth.
“It’s earnings growth that drives stocks over the long term,” said Tom Cassidy, chief investment officer at Univest Wealth Management Division. While “we won’t know if any of these policies will actually be implemented until later next year,” a continued rebound in earnings should nevertheless prop up stocks for additional gains, Mr. Cassidy said.
Earnings for companies in the S&P 500 grew 3.1% in the third quarter from a year earlier, according to FactSet, entering positive territory for the first time since the first quarter of 2015, when they grew 0.5%. Analysts polled by FactSet expect the rebound to continue, and are estimating a 3.2% growth rate in the fourth quarter of 2016.
An end to the longest earnings slump since the financial crisis also comes against a backdrop of improving economic data. U.S. gross domestic product, a broad measure of the goods and services produced across the economy, posted its strongest quarterly pace of growth in two years in the third quarter, according to data released by the Commerce Department in December.
The S&P 500 climbed 9.5% in 2016, its biggest gain since 2014.
While it’s only one quarter of earnings data, the return to growth is giving investors more reason to believe the stock market will keep climbing in 2017.
The improved outlook for financial companies also bodes well. The S&P 500 financials sector was up 20% in 2016 and was responsible for nearly half of the total earnings growth for the S&P 500 in the third quarter, according to FactSet data.
Financials posted 8% year-over-year earnings growth, according to FactSet. J.P. Morgan Chase & Co., Citigroup Inc., Wells Fargo & Co., Bank of America Corp., Goldman Sachs Group Inc. and Morgan Stanley all beat analysts’ estimates on an earnings-per-share basis.
Several lenders, including J.P. Morgan, the largest U.S. bank by assets, reported a rebound in their trading businesses. While low interest rates have for years cut into banks’ net interest margins--a key measure of lending profitability--events like the U.K.’s surprise vote to leave the European Union or uncertainty around the Fed’s next steps on interest rates have helped boost trading revenues, some of the banks said.
Many of the banks expect trading gains to continue. Executives at Citigroup, Bank of America and J.P. Morgan said at a banking conference in early December that they expect key fourth-quarter trading metrics to grow by double-digit percentages from the year-earlier period.
ENLARGE
But risks remain.
Industrials—which have helped lead the recent stock-market rally with a 7% gain in the S&P 500 since Election Day—are expected to report an earnings decline of more than 8% in the fourth quarter from the year-earlier period, according to analysts polled by FactSet.
Caterpillar is projected to be among the biggest drags on the sector’s earnings in the fourth quarter. Shares of the maker of construction and mining equipment—whose results are closely watched as a barometer for global manufacturing activity—gained 36% in 2016. But for the fourth quarter, the company is expected to report earnings of 66 cents a share, down from $1.02 a share at the start of the quarter, according to FactSet estimates. The company said in October that it could report a loss for the year, and it predicted another tough year for 2017.
A strengthening U.S. dollar could also hamper the earnings of multinational companies. While a stronger dollar increases U.S. buyers’ purchasing power abroad, it also makes U.S. exports more expensive to foreign buyers, putting pressure on the bottom lines of companies that receive a significant chunk of their revenue from abroad. Roughly 31% of S&P 500 revenues come from outside the U.S., according to FactSet estimates.
The dollar has rallied since Election Day on prospects of a higher-growth, higher-rate environment, which makes it more attractive to yield-seeking investors. The WSJ Dollar Index, which measures the dollar against a basket of 16 other currencies, gained about 3% in 2016.
The prolonged S&P 500 earnings slump has also helped make stocks more expensive than their historical averages. The S&P 500 was trading at around 21 times its past 12 months of earnings last week, according to FactSet. Its 10-year price/earnings average is 16.
“People are very inclined to ignore P/E values going up,” said Bret Chesney, senior portfolio manager at Alpine Global, who added that he thinks stocks are too expensive relative to how companies have performed over the past several quarters. “I wouldn’t be too gung-ho to invest at these levels.”
Still, many analysts believe there is reason to be optimistic about the coming year.
Corporate earnings are projected to grow by double digits through 2017. Analysts polled by FactSet expect earnings to grow 11% in the first quarter, 11% in the second quarter, 9.1% in the third quarter and 14% in the fourth.
“There’s some meat to the rally,” said Karyn Cavanaugh, senior market strategist at Voya investment Management. “I think 2017 is shaping up to be a good year.”