The Outlook for Earnings
What is the outlook for U.S. corporate earnings and what does it mean for stocks?
Earnings were in a recession, even while the economy grew, from 2014-2016. Earnings for most companies declined year over year during that period.
Late in 2016, we finally saw positive and even robust earnings growth. Analysts generally expect such strong earnings growth to continue.
I think they are correct for the most part. Several forces are currently pushing against earnings growth, but several other factors also make it likely that U.S. companies will continue to report strong earnings gains.
On one side, the economic recovery is extended, and the highest earnings growth usually is in the early stages of recovery. Also, companies regularly report that they are having trouble finding the workers they want. They expect to pay higher wages in the near future.
Higher wages should crimp profit margins. The low productivity of the last few years is another pressure on earnings and margins.
Yet, several factors are overcoming those negative forces and driving higher earnings, the main driver being stronger global growth.
The U.S. stock indexes are dominated by global companies, so stronger growth in Europe, Asia and Latin America increases their earnings. The last few years, most economies were declining or stagnant while the U.S. steadily grew. Now, the other economies are recovering.
In addition, it appears that cost pressures other than higher wages will remain restrained. Commodities are higher than their recent bear market lows, but they stopped rising. We’re not likely to see the sharp price increases that are normal for economic recovery because, worldwide, there still are strong deflationary pressures from the financial crisis.
If earnings growth is likely to be strong, should we load up on U.S. stocks? I don’t think so.
I think international markets provide better opportunities. U.S. stock prices already have a year or two of strong earnings growth priced in.
Investors still haven’t accepted that growth momentum is likely to continue outside the United States, so not much earnings growth is priced in non-U.S. stock prices. Also, overseas stocks are starting at very low levels and have a lot more potential growth ahead of them than U.S. stocks do.
The Data
The Philadelphia Fed Business Outlook Survey continues to indicate strong manufacturing conditions in the region. The index declined to 27.6 from 38.8. Last month’s reading was the second highest in more than 30 years, so some decline was expected.
The Empire State Manufacturing Survey also was positive, rising to 19.8 from last month’s negative 1.0. The survey was strong across the board.
Yet, we’re still not seeing these strong surveys and anecdotal reports translate into economic gains, as measured by the government. Industrial Production was flat, and the manufacturing segment declined 0.4%. Production of business equipment also declined 0.7%. The Industrial Production Index is up only a little over 2% over 12 months. That’s the highest level in a couple of years, but well below highs reached in 2014.
Home builder optimism declined a bit, with the National Association of Home Builders (NAHB) Housing Market Index declining to 67 from 70. Expectations for future sales remained strong, despite a drop in traffic to model homes, especially by potential first-time buyers.
Small business owners remain optimistic. The Small Business Optimism Index from the National Federation of Independent Business (NFIB) is below the 12-year highs reached a few months ago. However, it is unchanged from last month at 104.5 and remains close to the highs. Even so, small business owners are not optimistic about earnings or credit conditions and base their optimism on expectations of federal policy changes in taxes and regulations.
Inflation continues to take a break after rising in 2016. The latest Producer Price Index was unchanged, after climbing 0.5% last month. It was up 0.3% after excluding food and energy. The headline index was up 2.4% over 12 months. After excluding food and energy, the 12-month change was 2.1%.
The Consumer Price Index (CPI) declined by 0.1%. After excluding food and energy, the CPI rose 0.1%. The 12-month numbers are 1.9% and 1.7% gains, respectively. That’s near the Fed’s inflation targets, but inflation is lower than a few months ago. I think a lot of the recent decline in prices is due to some temporary factors, but it will take a few months to be sure of that.
New unemployment claims declined 8,000, leaving the weekly claims and four-week average near historic lows.
The Markets
The S&P 500 rose 0.24% for the week ended with Wednesday’s close. The Dow Jones Industrial Average gained 0.97%. The Russell 2000 rose 1.54%. The All-Country World Index added 0.17%. Emerging market equities lost 0.14%.
Long-term treasuries gained 1.06%. Investment-grade bonds rose 0.53%. Treasury Inflation-Protected Securities (TIPS) fell 0.33% and high-yield bonds appreciated 0.16%.
In addition, the U.S. dollar rose 0.22%.
Meanwhile, energy-based commodities lost 1.95%. Broader-based commodities fell 1.50%, while gold dropped 1.21%.
Bob’s News & Updates
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