INSIGHTS

On August 06, 2018

AAM Viewpoints – Earnings Continue to Surprise to the Upside

We are now seven full months into the year and though the majority of equity indices have had their ups and downs during 2018 there is one thing that is still heading up pretty much in a straight line – corporate earnings. Unfortunately, this fact seems to be alluding most investors at the moment. As they like to say, sometimes you can’t see the forest through the trees. Well, when it presently comes to earnings, it seems participants can’t see the earnings for the other noise. Currently there is way too much talk of yield curve inversions, recessions and trade wars (too name a few concerns). These concerns are worth investigating but they are causing many to miss the fact that earnings are on a tear and despite talk to the contrary, not yet at a peak. If you recall, peak earnings seemed to be the consensus as strong 1^st quarter 2018 results came in. With 2^nd quarter earnings beginning to wind down we think it is appropriate to take a closer look at the continued strong results.

Through Thursday August 2 we have just over 75% of the 2^nd quarter S&P 500 earnings reports in and we show 84.07% are running ahead of expectations compared to 81.53% at this same point last quarter (the long-term average is 73.69%). To be clear this is an impressive showing but we need more than just earnings that beat expectations – we also need strong earnings growth. So far this quarter we have S&P 500 year-over-year earnings growth of 24.16% compared to last quarter at 22.79% and last year at 9.69%. In addition, at this point last year expectations were for year-over-year earnings growth of just 18.02%, thus earnings are about one-third higher than expected. In a nutshell, whether you look sequentially, year-over-year or compared to long-term averages the current earnings trends are very solid and the growth isn’t just a byproduct of the recent tax cuts as the top line is experiencing strong growth as well. We show S&P 500 year-over-year revenue growth of 9.74% for the 2^nd quarter so far compared to last quarter at 8.54% and last year at 5.36%.

Given this data it should be pretty clear that the strong earnings are not just driven by tax cuts but are also, first and foremost, the result of a very strong and improving U.S. economy which is having a very positive impact on corporate revenues. In our opinion these trends should be able to continue, with or without tax cuts, for at least the next couple of quarters.

With strong earnings growth should come strong equity returns and so far in 2018 the latter has trailed our expectations a bit. However, we feel that despite the hurdles we mentioned above, plus the added weight of the midterm elections, that continued strong earnings growth will win out over the other concerns and help drive strong equity returns through the rest of 2018. Given this we our sticking with our target range of a total return of 13–17% for the S&P 500 in 2018 (through 8/2/2018 the S&P 500 has a total return of 6.89%, which is 11.92% annualized).

CRN: 2018-0803-6818 R