Retirement Watch Lighthouse Logo

It Is All about the Earnings

Last update on: Jul 19 2021

Rising earnings are boosting stock prices.

Until recently, central banks (especially the Federal Reserve) were prime movers of the markets. Quantitative easing was designed largely to increase stock prices by pushing money into the markets, and it largely had that effect.

But the Fed has been reducing its role since 2014. That pushes earnings and other fundamentals to the front of investor concerns.

One sign that earnings are more important is the decline of the “Trump Trade.” Companies that paid more than average in taxes outpaced the market after the election, apparently because of expectations that corporate tax reform would lower their tax bills. As the Trump initiatives stalled in Congress, the high-tax companies lost ground to others.

Several different forces affect earnings, and they’ve been pushing in opposite directions so far this year. Wages have been rising and productivity has been declining. That’s a double negative for earnings. But commodity prices generally are down, and that boosts the earnings of companies that use commodities and goods. (It hurts the earnings of commodity producers.)

The U.S. economy continues to grow, and growth is picking up in many other economies. That should boost sales and also give businesses some room to increase prices. Inflation remains low, so businesses apparently aren’t able to increase prices a lot. But they have more room than they did a few years ago.

Low interest rates continue to benefit earnings. Businesses can borrow to buy back stock and other companies. Either financial transaction can boost earnings at very low cost. Though the Fed has begun raising rates, the increases have been modest, and rates still are well below historic averages.

Businesses also have avoided investing much in new plants and equipment since the financial crisis. That lowers productivity and probably earnings over the long run. But in the short run, it reduces expenses and helps earnings.

The biggest boost to earnings for large public companies lately has been the dollar.

After several years of increasing in value, the dollar has declined in 2017. The decline has been unexpected and significant. Most indexes of the dollar against baskets of foreign currencies show the dollar to be down 8% or so this year. The dollar’s done particularly poorly against the euro, losing about 10%.

A weak dollar can help the earnings of U.S.-based multinational companies. Their goods and services are less expensive to foreign buyers. That can increase sales without changing costs much. Morgan Stanley estimates that every 2% decline in the dollar increases earnings about 1%.

Corporate earnings were in a recession until the end of 2016, when they started to recover. In the first quarter of 2017, earnings of the S&P 500 increased 18%. Consensus estimates for the second quarter are for a 7.2% earnings increase.

The second quarter earnings-reporting season began its heavy period this week. Several companies already reported that earnings increased more than expected at the start of the year, and attributed the higher earnings to the dollar. A number of companies have said the real boost from the falling dollar won’t kick in until later in the year.

Of course, the dollar can only decline so much. Also, at some point the negative factors for earnings could begin to overpower the positive effects from the dollar. So, we’ll have to see how long this dollar-fueled increase in earnings lasts.

The Data

Housing data dominated the releases this week. Once again, the data were mixed and some parsing is required to understand what’s happening. The bottom line is that housing still is recovering and making a positive contribution to economic growth.

Existing home sales declined by 1.8%, which was more of a dip than expected. Over 12 months, sales increased by only 0.7%. What’s worth noting is the inventory of homes for sale is steadily declining. The latest month’s inventory was 7.1% below what it was a year ago. For the last 25 months, inventory has declined, though the rate of decline has been slowing. Low inventory reduces the number of sales, because there are fewer homes to buy. It also increases prices, squeezing potential buyers out of the market. In the latest report, existing home sale prices were up 6.5% from 12 months prior.

New home sales did better. They increased to an annual rate of 610,000, which is one of the highest levels since the financial crisis. But it wasn’t all good news. Sales were higher in the first quarter of the year, and prices were down 4.2% to stimulate the sales. What we’ve been seeing for a couple of years is new home sales improving while existing home sales are steady or down. In the years after the financial crisis, existing homes far outpaced new home sales, because so many existing homes were selling at foreclosure or other distress sales. The balance between existing home sales and new home sales has been slowly moving back to normal.

Two other reports this week confirmed that low inventory is increasing prices. The FHFA House Price Index increased 0.4% for the month and 6.9% over 12 months. The 12-month increase now is the highest in three-and-one-half years.

Likewise, the S&P CoreLogic Case-Shiller House Price Index increased 0.8% for the latest month and 5.7% for 12 months. This index is a month behind the FHFA index.

Manufacturing is improving in the mid-Atlantic region, according to the Richmond Fed Manufacturing Index. Last month’s index was revised higher to 11 from 7. This month’s index was reported as 14. This was the ninth consecutive monthly increase for the index, and its components were almost all positive.

The mid-month PMI Composite Flash Index reported the economy popped a bit in early summer. The composite rose to 54.2 from 53. Both the manufacturing and services components had solid increases.

Durable Goods Orders for June were mixed, but you wouldn’t know that without diving into the data. The headline number showed a 6.5% increase for the month and 16.1% for 12 months. But the rise was due to a large number of civilian aircraft orders being booked for the month. Exclude transportation and the numbers are a 0.2% increase for the month and a 6.8% increase over 12 months. Core capital goods, which reveal business investment in basic equipment, declined 0.1% for the month and increased 5.6% over 12 months.

Even more interesting were the revisions to last month’s data, which reveal some of the problems with government data. Last month’s 1.1% decline in headline Durable Goods Orders was improved to only a 0.1% decline. The 0.2% decline in core capital goods was improved to a 0.7% increase. If June’s data are revised similarly, the second quarter suddenly will appear to be a strong one for manufacturing. Before the revisions to the May data, manufacturing looked extremely weak.

Consumer Confidence, as measured by The Conference Board, increased to 121.1 from 117.3 after three months of declines. This measure hasn’t declined nearly as much recently as the Consumer Sentiment measure from the University of Michigan. This now is the eighth straight month above 110, which hadn’t occurred in more than 20 years.

Last week, new unemployment claims declined by 14,000, and this week they increased by 10,000. That leaves the four-week average essentially unchanged. The weekly and four-week numbers remain near historic lows.

The Markets

The S&P 500 rose 0.17% for the week ended with Wednesday’s close. The Dow Jones Industrial Average returned 0.32%, while the Russell 2000 gained 0.04%. The All-Country World Index added 0.24% and emerging market equities increased 0.23%.

Long-term treasuries declined 0.76%. Investment-grade bonds lost 0.04%, while Treasury Inflation-Protected Securities (TIPS) fell 0.13%. Finally, high-yield bonds added 0.26%.

The dollar fell 1.14%. It now is down 8.23% for the year to date.

Energy-based commodities had another strong week with a 0.92% return. (They’re still down 8.26% for 2017.) Broader-based commodities returned 0.08%, while gold gained 0.50%.

Bob’s News & Updates

You might want to join me at the MoneyShow San Francisco, Aug. 24-26, because I’ll be making three presentations and there will be dozens of other speakers. For free registration and other details, click here.

Do your heirs know how to handle an inherited IRA? If not, they’ll join the long list of heirs who made simple mistakes that triggered additional taxes and penalties. To avoid this result, be sure your heirs have a copy of Bob Carlson’s Guide to Inheriting IRAs.

The missing link in many retirement plans is a strategy for withdrawing money from the nest egg to ensure it lasts 30 years or more. If you don’t have a plan, learn more in the revised edition of “The New Rules of Retirement.”

bob-carlson-signature

Retirement-Watch-Sitewide-Promo

Log In

Forgot Password

Search