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93% of S&P 500 companies have reported second-quarter earnings; the remainder will continue into early September. As of this writing, bottom-up earnings for the S&P stand at $32.63, representing a 5.9% quarter-over-quarter increase and a 10.6% year-over-year increase. In short, earnings are strong — and with four quarters of earnings growth under our belts, we can say that the 2015–2016 “earnings recession” is firmly behind us.
Data Source: Bloomberg
Earnings growth has been led by energy, technology, financials, and healthcare; the sectors with the most companies beating estimates have been tech, healthcare, industrials, and financials. On average, operating margins have again reached record highs.
U.S. multinationals were another point of strength. 55% of U.S. companies in the top 10% of foreign exposure have beaten on both EPS and sales, compared to 30% of companies with pure domestic exposure. Those beats have been driven by companies with exposure to emerging markets; 60% of those with high EM exposure beat on their top and bottom lines, while only 37% of those with high European exposure did so.
We listen to many company earnings conference calls, and the sentiment being expressed by managements has in general remained strongly positive, often commenting on improved demand. The beneficiaries of secular technological trends have been particularly optimistic, but so have cyclical companies experiencing strong demand growth. Sentiment is positive on Europe, but even more positive on demand in Asia, and particularly in China. Many companies have commented on the success with which productivity improvements are enabling them to offset cost pressures.
In short, the developing 2017 earnings picture is reinforcing many of our views about the current state of the U.S. and global economy and stock markets.
• The continued weakness of the U.S. dollar will benefit large U.S. multinationals by supporting foreign demand for their goods and services. The strength or weakness of the dollar continues to be a key variable, and investors should watch it closely.
• Global demand continues to be supported by a coordinated global uptick in GDP growth. (Over the weekend, for example, Japanese data came in showing an annualized GDP growth rate of 4% in the second quarter. This is the strongest growth streak in Japan for more than a decade.)
• Within the U.S., while benefits are continuing to accrue to some cyclical companies which previously benefitted from the “Trump trade,” more benefits are accruing to secular growers in technology, where growth can continue independent of political vicissitudes. In the absence of decisive government action on taxes and infrastructure, the market is continuing to favor growth stories in technology.
Investment implications: We remind readers again that the period between mid-August and the first half of October is often a difficult one for the U.S. stock market. If this year follows the usual seasonal pattern, we believe that it will present buying opportunities. Global economic fundamentals remain favorable — particularly economic growth and moderate U.S. dollar strength. Global central bank policy, although coming closer to an inflection, remains supportive as well. We believe that investors should use weakness to add to positions, particularly in the stocks of large U.S. technology companies, many of which remain cheap from the perspective of future earnings growth. We continue to prefer manufacturing-based emerging markets both to EM commodity exporters and to Europe.
To learn more about Guild Investment Management, please go to www.guildinvestment.com.
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