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AAM Viewpoints – Will Earnings Trump the Tariffs?


We like to provide a deep dive into earnings trends at least once a year and given that we are finishing up what – based on year-over-year earnings growth – is the worst earnings season in three years, we felt the time was appropriate. We will start with the bad news, but the good news is there isn’t as much bad news as was originally feared and still plenty, we believe, to cheer.


With 95% of the S&P 500 companies reporting 1st quarter earnings we show 77.23% are running ahead of expectations with a market-cap weighted year-over-year growth of 2.23%. The long-term average for these two numbers is 74% and 8% respectively. Clearly the current read of 2.23% is below the long-term average but it is well above the level of -7.85% that was achieved in the 1st quarter of 2015 and is also well above the level of -4.20% that was predicted just 60 days ago. This is important to note because when it comes to earnings it’s not just the absolute level that can affect markets but also their level relative to what was expected. In this case the actual earnings came in much better than expected and we feel this bodes well as we all attempt to navigate what is becoming a somewhat frustrating and escalating global trade situation.


A big factor in the predicted year-over-year earnings decline for the 1st quarter was the uncertainty of the effects from the tariffs that had gone into effect over the last year. As a quick review, the imposition of new tariffs began modestly and unilaterally in January 2018 and have since escalated in breadth and magnitude into what many are now classifying as a full-on multilateral trade war. In addition, when you throw in the fact that the tenor of the war can change on a dime as it literally plays out “tweet-to-tweet,” and you have a very tough situation to game. The base case still seems to be that there will be a positive resolution, but as time drags on this camp is eroding and there appears to be more pessimism building. This has contributed to increased market volatility of late and, we believe, increased opportunities for patient investors.


As we analyze the earnings it appears to us that so far corporate America is doing a very good job of mitigating the impact of the tariffs and the fear of rising costs they may impart. Looking at the PPI (Producer Price Index) we show the current level of 2.0% is well below the one-year average of 2.5% and the year prior’s average of 3.0%. The same trends hold for the CPI (Consumer Price Index). As time goes on we believe U.S. corporations will become even more adroit in navigating the tariff landscape and this clearly demonstrates the power of capitalism and innovation at work.


Given our strong economic base grounded on a very solid employment picture we believe we are well set up to navigate the stress and strain of a trade war as it progresses in the near-term. In addition, reasonable valuations – the S&P 500 is trading about 2% below its 20-year average trailing P/E (Price-to-Earnings ratio) – should provide some support for stocks as the trade war jabs continue to fly. Lastly, it appears the FOMC (Federal Open Market Committee) is positioned to adjust rates as necessary if the U.S. economy begins to show signs of fatigue brought on by the trade war. However, it appears the capital markets are already ahead of the curve. The U.S. 10-Year Treasury Note currently sits at 2.13%, well below its one-year high of 3.24% and one-year average of 2.79%. On the shorter end, we show three-month LIBOR has come down 35 basis points in the last six months. We believe both moves should translate to lower rates for consumers and help keep them interested in housing and vehicles.


However, for now, the need for the FOMC to step in appears to still be over the horizon. This week it was reported that vehicle sales came in at 17.3 million (five-year average is 17.2 million) just above expectations of 16.9 million. We also had the ISM Manufacturing Index post a reading of 52.1 (five-year average is 54.8) and the ISM Non-Manufacturing Index post a reading of 56.9 (five-year average is 57.0). Readings above 50 signify expansion and with the Non-Manufacturing side the dominant portion of the U.S. economy it appears we are still, despite the trade headwinds, in a modest growth phase.


Over the next year S&P 500 earnings are expected to grow 12% and given the recent performance of earning we believe there is potential for upside to that level. When you also consider the S&P 500’s current attractive long-term valuation and an attune FOMC it leads us to believe the equity markets can weather a modest extension in the trade war, but a much greater escalation from here could prove to be too much weight for the markets to “bear.” We are hopeful that some meaningful progress comes from the G20 meeting scheduled for late June in Osaka, Japan.


 


CRN: 2019-0603-7462R  


This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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