Tuesday, January 3, 2017

Earnings, Not Donald Trump, Are Stocks’ Best Friend In 2017

Continued rebound in corporate profits should prop up share prices regardless of Washington policies.

By Akane Otani 
The Wall Street Journal
January 4, 2017

Wall Street expects U.S. companies to report gains in fourth-quarter earnings in coming weeks, extending a recent recovery and providing fresh fuel to major U.S. stock indexes after a run of records in late 2016.

On Tuesday, the first trading day of 2017, shares of financial companies surged, in part on optimism for their profitability this year, helping the Dow Jones Industrial Average jump 119.16 points to 19881.76, snapping a three-session losing streak. The broader S&P 500 added 0.85%.

Earnings at S&P 500 companies will rise 3.2% from a year earlier in the fourth quarter, according to analysts polled by FactSet. That builds on a 3.1% gain in the third quarter, which marked the first year-over-year rise in corporate earnings since the first quarter of 2015 and could point to a more lasting breakout, analysts said.

The fourth-quarter earnings season kicks off in earnest Thursday, with Walgreens Boots Alliance, Monsanto Co. and Constellation Brands expected to report results that day. Banks, including J.P. Morgan Chase & Co., are slated to report results Jan. 13. By the end of January, 149 companies are expected to have reported results, according to the WSJ Market Data Group.

Donald Trump’s election revved up investors’ hopes for business-friendly policies and the gains since Nov. 8 in major stock indexes have largely been attributed to the potential for tax cuts, looser regulation and fiscal spending under the new administration.

Investors say another strong quarter of earnings reports could help bridge the gap between now and later this year, when many expect Congress to begin enacting policies that aim to speed up economic growth and would likely bolster corporate profits. Corporate profits are among the strongest determinants of market performance, investors and analysts say.

“It’s earnings growth that drives stocks over the long term,” said Tom Cassidy, chief investment officer at Univest Corp. of Pennsylvania’s Wealth Management Division. While “we won’t know if any of these policies will actually be implemented” until later in the year, a rise in earnings typically results in additional stock gains, Mr. Cassidy said.

Analysts expect earnings at S&P 500 companies to grow by 11% from a year earlier in the first quarter, 11% in the second quarter, 9.1% in the third quarter and 14% in the fourth, according to data from FactSet.

It is a long-awaited improvement. An end to the longest earnings slump since the financial crisis comes against a backdrop of improving economic data.

Valuations have risen above their long-term average, prompting many analysts to warn that stock gains could be vulnerable without an upswing in corporate profits.

U.S. gross domestic product, a broad measure of the goods and services produced across the economy, posted its strongest quarterly pace of growth in two years in the third quarter, according to data released by the Commerce Department in December.

On Tuesday, the Institute for Supply Management’s manufacturing index rose in December to its highest levels in two years, the latest sign of momentum in the U.S. factory sector. Separately, Markit’s manufacturing index rose to a 21-month-high last month.

Some analysts point to an improved outlook for financial companies, driven in part by expectations that Trump administration policies will boost growth and inflation, resulting in a steeper “yield curve” that benefits banking firms’ profits.

The S&P 500 financials sector was up 20% in 2016 and was responsible for nearly half of the total earnings growth for the S&P 500 in the third quarter, according to FactSet data.

Financials posted 8% year-over-year earnings growth, according to FactSet. J.P. Morgan Chase, Citigroup Inc., Wells Fargo & Co., Bank of America Corp., Goldman Sachs Group Inc. and Morgan Stanley all beat analysts’ estimates on an earnings-per-share basis.

Several lenders, including J.P. Morgan, the largest U.S. bank by assets, reported a rebound in their trading businesses. While low interest rates have for years cut into banks’ net interest margins—a key measure of lending profitability—events like the U.K.’s surprise vote to leave the European Union or uncertainty around the Federal Reserve’s next steps on interest rates have helped boost trading revenue, some of the banks said.

Many of the banks expect trading gains to continue. Executives at Citigroup, Bank of America and J.P. Morgan said at a banking conference in early December that they expect key fourth-quarter trading metrics to grow by double-digit percentages from a year earlier.

Utilities are expected to perform well, too. Analysts polled by FactSet see earnings for the S&P 500 utilities sector growing by 20% for the fourth quarter from a year earlier. Technology, consumer staples and health care are expected to report earnings growth in the single-digit percentages for the fourth quarter.

But risks remain.

Industrials—which have helped lead the recent stock-market rally with a 7% gain in the S&P 500 since Election Day—are expected to report an earnings decline of more than 8% in the fourth quarter from a year earlier, according to analysts polled by FactSet.

Caterpillar is projected to be among the biggest drags on the sector’s earnings in the fourth quarter. Shares of the maker of construction and mining equipment—whose results are closely watched as a barometer for global manufacturing activity—gained 36% in 2016.

But for the fourth quarter, the company is expected to report earnings of 66 cents a share, down from expectations of $1.02 a share at the start of the quarter, according to FactSet estimates.

The company said in October that it could report a loss for the year and predicted another tough year for 2017 amid weak demand.

A strengthening U.S. dollar could also hamper the earnings of multinational companies. While a stronger dollar increases U.S. buyers’ purchasing power abroad, it also makes U.S. exports more expensive to foreign buyers, putting pressure on the bottom lines of companies that receive a significant chunk of their revenue from abroad. Roughly 31% of S&P 500 revenue come from outside the U.S., according to FactSet estimates. The dollar has rallied since Election Day on prospects of a higher-growth, higher-rate environment, which makes it more attractive to yield-seeking investors. The WSJ Dollar Index, which measures the dollar against a basket of 16 other currencies, gained about 3% in 2016.

The prolonged S&P 500 earnings slump has also helped make stocks more expensive than their historical averages. The S&P 500 was trading at around 21 times its past 12 months of earnings last week, according to FactSet. Its 10-year price/earnings average is 16.

“People are very inclined to ignore P/E values going up,” said Bret Chesney, senior portfolio manager at Alpine Global, who added that he thinks stocks are too expensive relative to how companies have performed over the past several quarters. “I wouldn’t be too gung-ho to invest at these levels.”

Still, many analysts believe there is reason to be optimistic about the coming year.

“There’s some meat to the rally,” said Karyn Cavanaugh, senior market strategist at Voya investment Management. “I think 2017 is shaping up to be a good year.”

Article Link To The Wall Street Journal: