Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: Fourth-quarter earnings season is set to kick off. What is Wall Street expecting for the quarter and for the year?
Stovall: Wall Street expects the earnings recession to have ended with the second quarter of 2016, therefore the fourth quarter will be the second positive quarter of this earnings recovery. For the full quarter, we’re expecting a 4.4% gain, and for the full year, expecting it to be basically flat with 0.0%. That’s still an improvement of 0.6% decline that we saw for all of 2015.
EQ: You mentioned in this week’s Sector Watch report of the usual margin between actual results and estimates. As a result, could we end up with actual earnings growth as opposed to EPS growth being flat for the year?
Stovall: Absolutely. What we’ve seen over the past 19 quarters is the actual quarterly results have come in 3.5 percentage points better than the beginning-of-quarter estimates. Right now, with beginning-of-quarter estimates being at 4.4%, we really could be rivaling 8% growth when all is said and done and the actuals are in place. So, I think that is a whisper number that investors are using in the back of their minds, and is one reason why they remain optimistic on the market even though the trailing four-quarter GAAP earnings P/E ratio is at the second-highest level since World War II.
EQ: Perhaps more than anything, investors will be listening most intently for corporate guidance, particularly as it relates to the new environment in the coming year. What should investors be looking out for when doing so?
Stovall: First off, I think they just have to see if company management is willing to say that things might be improving in 2017. I say that because while analysts tend to underestimate growth in the quarter ahead, they tend to overestimate growth in the four quarters (or 12 months) ahead, mainly because company management does not give them a lot of 12-month guidance, but they’re happy to guide lower so that when they do report their quarterly results, they end up beating them.
We’ve found that over the past five years the full-year numbers came in 5.5 percentage points below the initial estimates that were made 12 months earlier. So if that were the case, instead of getting about 12% earnings growth for all of 2017, we would probably end up with 6.5% growth. But maybe that will be different this year because of the possibility of a tax cut by the Trump administration, combined with the prospects of infrastructure spending that could end up seeing most of the gains occur in 2018.
EQ: The Energy sector is expected to post an EPS decline of 8%, which while bad, is actually a significant improvement from the previous three quarters. It’s also poised for a huge rebound in 2017. Is this group set to move from laggard to leader?
Stovall: Absolutely. In 2015, the S&P 500 posted an earnings decline of almost 1%, and you could say the blame really fell on the Energy sector. Without Energy, S&P 500 earnings would have been 7%. In 2016, earnings are expected to be flat for the S&P 500, but without Energy, they’re expected to be up 4%. As we look to 2017, leaving out Energy, earnings would be up about 7%. But keep them in, and earnings are expected to be up 12%. So for 2015 and 2016, Energy earnings were a headwind, yet for 2017, they are now projected to be a tailwind.
EQ: While the S&P 500 is expected to show flat EPS growth for 2016, it’s projected to see 11.8% EPS growth for 2017 with eight of the 11 sectors in high single-digit or double-digit growth, and only Utilities the only one in the red. What are some catalysts pushing the growth we’re seeing across the board?
Stovall: I think first off, we’re really dealing with easier comparisons. It’s easier to show good earnings growth when a majority of quarters 12 months before showed earnings declines. Also, as we just discussed, Energy is going to end up being a tailwind in 2017 rather than the headwind that it was in 2016. Finally, we’re just basically seeing an improvement in overall economic growth, which is likely to help boost, but certainly not propel, earnings in 2017.
