Have we Reached Peak Earnings for This Cycle?

Most companies now have reported their first-quarter earnings, and the overall results are outstanding. Almost 70% of companies exceeded the earnings estimates for the quarter, and more than 72% exceeded revenue estimates.

The percentage of companies exceeding earnings estimates was the highest since 2006 and among the highest since 1999. A large percentage of companies also exceeded revenue estimates, making the first quarter the second best for this measure since 2004 and one of the best since 1999.

The earnings for the first quarter exceeded earnings of the same quarter in 2017 by 25.3%, according to The Wall Street Journal. That’s the strongest gain in more than seven years, and it was the seventh straight quarter of profit growth.

A combination of tax cuts and economic growth drove the profit increases. The Journal said more than half the net income growth reported by 200 large companies was from a decline in taxes. For many companies, revenues and income rose but tax bills decreased. Also, pre-tax earnings rose about half as fast as after-tax earnings, according to Thomson Reuters.

But revenues also increased rapidly and more than expectations, so more than tax cuts pushed earnings higher. The economy continues to grow at a decent clip.

But as I pointed out a few weeks ago, the stock market didn’t rise as higher earnings were reported for either the fourth quarter of 2017 or the first quarter of 2018.

It could be that investors believe earnings growth is peaking for this cycle. They see the Fed continuing to raise interest rates and inflation rising. Wages are rising at a faster rate than earlier in the recovery, and companies are facing pressure to continue increasing wages because unemployment is so low. In surveys, many businesses report that the biggest problem they face is finding qualified employees for their job openings. Companies expect to increase compensation over the next year.

Also, while the tax cuts will stay in place, the jump they gave to earnings and cash flow is a one-year occurrence. To match this earnings season, companies will need to find something else to match the boost the tax cuts gave earnings.

In 2017, the economy performed better than initial expectations, and investors reacted by paying higher prices for stocks as the year progressed. Growth beyond 2017 probably is already reflected in stock prices.

In the past couple of years, the economy and earnings experienced mostly tailwinds. Now, there are some headwinds, and some of the tailwinds are fading. I don’t anticipate a profits recession or an economic recession, but earnings growth is likely to stabilize. Earnings have to catch up to stock prices, and any earnings disappointments will hurt stock prices.

Note: I’m traveling on May 10, so the market and economic data in this edition are through the close of business on May 8.

The Data

Small business optimism is holding steady. The NFIB Small Business Optimism Index rose to 104.8 from 104.7. The survey reported the highest earnings improvement in 45 years. The biggest problem reported by business owners continues to be finding qualified workers for job openings.

Wholesale inflation remains moderate. It rose 0.1% for the month, following last month’s 0.3% increase. Less food and energy, the Producer Price Index increased 0.2% for the month. The 12-month increases were 2.6% for the headline index and 2.3% less food and energy.

Consumer Credit reflects the recent weakness in retail sales. While overall credit increased, the increase was mostly in student and auto loans. Credit card debt declined, following a decline last month. It’s another example of the optimism in consumer surveys not being reflected in real economic activity.

Last week’s Employment Situation reports were filled with surprises. Job growth was below expectations, but still a respectable 164,000 jobs were created and last month’s number was revised higher. The unemployment rate declined to 3.9%, yet average hourly earnings increased only 0.1%. That gives hourly earnings a 2.6% increase over 12 months.

The JOLTS (Job Openings and Labor Turnover Survey) report told a similar story. It reported a strong increase in job openings. But the gap between openings and new hires now is the largest on record. It appears that demand for qualified labor is much higher than the supply at this point.

The Markets

The S&P 500 rose 0.73% for the week ended with Wednesday’s close. The Dow Jones Industrial Average returned 1.10%. The Russell 2000 added 2.44%. The All-Country World Index increased 0.64%. Emerging market equities declined 0.58%.

Long-term treasuries increased 0.24% for the week. Investment-grade bonds lost 0.07%. Treasury Inflation-Protected Securities (TIPS) returned 0.12%, while high-yield bonds fell 0.04%.

On the currency front, the dollar rose 0.74%.

Energy-based commodities climbed 1.96% for the week. Broader-based commodities returned 0.52%. Gold rose 0.72%.

Bob’s News & Updates

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