Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: Minutes from the Fed’s meeting in March, in which it decided raise interest rates, were released Wednesday. What were some of the takeaways for you?
Stovall: First off, I think there was no surprise that the Fed is looking to continue to raise rates in 2017. Right now, the consensus is for two more rate hikes through the end of the year. The real question, however, revolves around the Fed’s balance sheet and their policy. What are they going to do? Are they actually going to start unwinding this balance sheet? Certainly, there was a discussion that was mentioned in the most recent minutes, but I think we’re too far away from coming to any kind of consensus as to how it would be done.
With that said, however, most did agree that when they did engage in shrinking the size of their balance sheet, it should be done in a passive and predictable manner. So, with regards to the shrinking of the balance sheet, the Fed will be embracing a similar process to that of the rate tightening program, which is try to indicate to the broadest number of investors as soon as possible what their intentions are in terms of magnitude as well as the overall duration, which I think should go a long way to calming investors’ nerves.
EQ: Earnings reporting season for the first quarter is upon us again. Expectations are for EPS growth of nearly 10% year-over-year. What are the expected main drivers of the strong gain?
Stovall: Well, I think the primary driver is easier year-over-year comparisons. In the first quarter of 2016, we had the S&P 500 post a 6.7% decline in earnings. We had seven of 11 sectors post earnings decreases, and one of those that had an increase was less than 1%. So, you had an awful lot of sectors, combined with the market, that were in a tailspin. So, it’s therefore much easier to be emerging from that a year later.
We find that seven sectors are expected to post positive earnings in the first quarter of 2017, and the decliners are expected to be Consumer Discretionary, Industrials, Telecom and Utilities. You also have three of the sectors (Financials, Information Technology and Materials) that are expected to post mid-teens growth.
EQ: The Energy sector’s recovery is anticipated to play a big part in the S&P 500’s projected earnings growth for 2017, but is deemed not meaningful in Q1. How would you describe the expectations for the Energy sector’s recovery?
Stovall: The pace has been pretty good and consistent. In the first quarter of 2016, the S&P 500 Energy sector posted an EPS loss of 35 cents. That’s not a year-over-year percent decline, but an outright loss of 35 cents. In the second quarter, we saw earnings up 75 cents, then $1.61 in the third quarter, and then $2.12 in the fourth quarter of last year. Now, that successive growth is expected to continue with earnings expected to be $3.04 for the first quarter of this year, rising to almost $5 by the end of this year. So, the trajectory is something that is causing investors to breathe a sigh of relief.
EQ: In this week’s Sector Watch report, you noted that a strong performance in Q1 EPS results could help to validate the market’s optimism of the current administration’s economic policies. In regards to this aspect, what should investors be looking for in results and management guidance?
Stovall: Guidance is usually hard to come by. So, let’s first focus on the results, which are good due to organic growth—meaning you get earnings increases as well as revenue improvements. That’s the best of both worlds. If you have earnings growth because of a reduction in the number of shares or other accounting practices that improve the earnings per share, then that becomes a little more problematic. I think what investors are really hoping for, and what’s keeping S&P 500 valuations elevated, is that there will be some sort of a Trump tax package that gets passed this year.
Whether that ends up being retroactive to the beginning of 2017 or starts at the beginning of 2018, is anybody’s guess. But I think investors are basically saying there are two things working in their favor. First, the economy is improving, so we should see an improvement in earnings and revenues. Second, with a potential tax cut, that should help validate the euphoria that’s been injected into the market since the election.
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