Markets in the Spotlight: US Equities
Markets in the Spotlight: US Equities

What this chart shows The number of S&P 500 companies issuing positive annual earnings per share (EPS) guidance during fourth quarter earnings season.


Source:  LPL Research, FactSet


Overview

S&P 500 companies have reported fourth quarter earnings growth of over 15%, an outstanding result although more impressive was the strong corporate guidance for 2018 earnings growth. Consensus S&P 500 operating earnings estimates for 2018 have increased by more than 7%, representing an unprecedented lift in earnings in what is already a favourable earnings environment. The breadth of optimism is apparent from the chart, with the number of companies raising guidance for this year double the highest levels of the past decade for the same period.

Event

US fourth quarter earnings season produced earnings and revenue growth of 15.3% and 8.2% year-on-year, respectively, the best growth in six years and marking the 35th straight quarter in which S&P 500 earnings beat consensus estimates. The 77% revenue beat rate is the best rate in the 10 years of available data, while the earnings beat rate (77%) was solidly above the average of the current economic expansion (70%). Finally, 10 of 11 S&P sectors produced year-on-year earnings growth, with 9 sectors reporting over 7% growth.

Impact

Consensus 2018 earnings growth estimates have increased by more than 7% with most of the increase driven by the new US tax law, which will favourably impact US corporations via a reduced tax burden, provision for immediate expensing and repatriation of foreign-sourced profits. Given earnings estimates have historically dropped by an average of approximately 3% during earnings season, the recent 7% positive revision is more like a 10% increase in potential corporate earnings growth. Of those three percentage points, perhaps one can be attributed to a weak US dollar, as US multinationals receive higher profits when translated back into a weaker US dollar. Which leaves two percentage points of upside possibly driven by the favourable macroeconomic and business climate; companies are optimistic, which is evident in business confidence surveys and this optimism traditionally translates into improved business investment.

Significance

Fourth quarter earnings season has produced exceptional results and very optimistic outlooks from corporate America that should bode well for future earnings growth. 2018 earnings will be supported by stronger global economic growth, a pickup in business spending, and strong manufacturing activity in the United States. Operating margins will likely remain strong and stable given only modest upward pressure on wages and other input costs, while the new tax laws will reduce tax burdens. With earnings likely to be the primary driver of returns in 2018, an increase in earnings estimates for this year will justify higher levels on the S&P 500. Consensus earnings per share estimates for 2018 are $152.50, representing growth of 15% on 2017, which indicate the S&P 500 is currently trading at a forward Price Earnings (PE) ratio of 18.2 times and a Price to Growth (PEG) ratio of 1.21 times.