INSIGHTS

On April 24, 2017

AAM Viewpoints – A Bird in the Hand AND Two in the Bush

The Trump Rally has paused. A pause might be considered a moral victory given some of the many geopolitical uncertainties. It’s been about seven weeks since the S&P 500 reached its all-time high of 2395.96 on 3/1/2017, however the benchmark index has traded lower for six consecutive weeks since hitting the high-water mark and currently sits -1.67% from that level (on a price basis, as of 4/20/2017). If the current “pause” turns into a “pullback,” we would expect it to be short lived before the market found support and eventually moves on to higher levels over the next 12 months. We believe higher levels may be possible due to the luxury of a relatively stable macro-economic foundation, in addition to possible tailwinds coming out of Washington including the Trump administration’s top agenda items of tax reform and infrastructure spending.

According to FactSet, analysts are expecting an 8.9% increase in earnings per share (EPS) for the S&P 500 Index for the first quarter of 2017. Due to managerial tendencies to beat analysts’ expectations, we could likely see double-digit growth for the quarter. Over the past five years, 68% of S&P 500 companies have exceed estimated earnings by an average of 4.1%. Based on the average number and magnitude of upside earnings surprises, we expect an additional 2.8% of earnings growth on top of current estimates, putting our target at about 11.7% (8.9% + 2.8%). For all of 2017, analysts are projecting similar growth of 9.7%.

The potential for fiscal stimulus has raised high expectations for a boost to growth; notably individual and business tax relief and a $1 trillion infrastructure investment over ten years. Assuming an agreement on taxes and an infrastructure bill comes to fruition, Ned Davis Research estimates a reduction in the corporate tax rate to 15-20% should boost EPS for the S&P 500 Index by 7-18%. This would be in addition to the already robust earnings environment. The proposed infrastructure investment plan, individual and corporate tax cuts, and increased defense spending could increase nominal gross domestic product (GDP) by 0.5% to 3.2% in 2017 and 2018. Again, that’s on top of a relatively stable macro-economic foundation.

Factoring in probabilities, the expected value of fiscal stimulus is clearly lower, but any additional growth is essentially “just the cherry on top.” The earnings rebound is clearly underway despite Washington, leaving the equity market uniquely positioned to reflect a bird in the hand and two in the bush.

CRN: 2017-0403-5883 R