How Trump stocks can rally without Trump
The economic outlook faces clear risks on both sides of the Atlantic though strong corporate profit growth looks set to last till the year end at least.
A bounce back from the sluggish UK profits of 2016, during pre-Brexit vote uncertainty, is coinciding with a revival in corporate returns in Europe, as a stream of data sound the first real-terms economic reveille there this decade. As for the largest listed U.S. firms, which are well into a recovery cycle that followed the financial crisis, profits growth is hitting a more than five-year high.
Of about 480 S&P 500 firms to have released first quarter (Q1) results by Tuesday, 75% beat mean expectations according to consensus data providers FactSet Research and Thomson Reuters I/B/E/S. Earnings rose about 14% on average year on year. It was the fastest earnings advance since profitability jumped by 16% in Q3 2011.
All in, U.S. Inc.’s earnings progress suggests companies are more than getting the better of a number of formidable headwinds. These include trade uncertainties from a possible rise in protectionist U.S. policies, the drag from a greenback that was at multi-year highs for some of the quarter, rising borrowing costs as the Fed ratchets rates higher to keep pace, and not forgetting concerns about President Donald Trump’s ability to push through corporate tax reforms.
With U.S. earnings nonetheless remaining resilient, there are grounds for optimism about the trajectory of earnings in the quarters to come, even if political sticking points stay intractable.
Oil earnings surge into Q4
That said U.S. earnings progress does have some flattering artefacts. These are most visible in the S&P 500’s Energy industry sector, where earnings surged a stonking 652.9% year-on-year. In fact, several components of the sector reported parlous results in the same quarter a year before and the stellar rate of improvement largely reflects their swing into profits from losses. The effect also suggests such percentage performances will moderate soon enough, particularly whilst oil price rises are still tardy.
For Q2, Q3 and Q4 though, energy company earnings are forecast to keep rising at triple-digit percentage rates, before the effect washes out in the first quarter of 2018, when profit is seen up 60%. In the meantime, stock price momentum in the sector might well follow earnings momentum.
The worst performing U.S. sector in Q1 was Telecom Services, weighed down by a 20% drop in earnings at the world’s biggest mobile phone company, Verizon, and a slide in revenues at rival AT&T. In this segment too though, there were non-performance related effects to bear in mind. Chiefly, that over the last several years, the number of sector index members has fallen—partly due to M&A— to a paltry 10 stocks. The increasingly threadbare sector has even prompted index compiler S&P Dow Jones Indices to consider discontinuing the group. Telecom Services now represents just 2% of the S&P’s entire capitalisation compared to 9% at its peak in 1999.
Among the most gargantuan U.S. companies, say those with a market capitalisation above $30bn, industrials and technology firms are forecast to continue dominating the earnings growth stakes. Screening for the highest percentile in terms of analyst coverage shows the most impressive earnings rises for the remainder of the year are expected to come from China-based e-commerce group JD.com, Caterpillar, the world’s largest construction equipment group, Microsoft, Adobe, PayPal, graphic card maker NVIDIA, JPMorgan and others.
The international flavour of these groups again suggests that at the top end of U.S. Inc., growth is widely expected to continue almost regardless of fiscal, monetary and governmental conditions. Still, on average earnings are expected to rise by a more modest 8%, 9% and 13% in Q2, Q3 and Q4.
European profits spring forwards
In Europe, it’s been a similarly expansive quarter. Among the largest European companies listed on the benchmark STOXX 600 index, around 256 companies have reported Q1 earnings to date. Of these 63.7% reported earnings above analyst estimates. In a typical quarter the rate of ‘beats’ is 49.5%, according to Thomson Reuters, which includes earnings seasons going back to 2011 in its calculations. In Europe, economic conditions are rebounding after two years of multi-billion monthly injections of cheap cash from the ECB. In turn, this is paving the way for the best corporate growth rates in over a decade. Earnings are forecast to rise 10% on average when the reporting season is complete, though again, removing the energy sector, growth is expected to look more modest, just 5%.
Businesses across the Eurozone have maintained April's blistering growth rate this month, according to data from IHS Markit released on Tuesday. Firms even reported that they were struggling to meet growing demand. That suggests the bloc's economic momentum is set to be sustained for at least the remainder of the year.
Among the more storied corporate industrial segments, banks will continue to attract attention. Investors are hotly anticipating a signal from the ECB as to when it will begin winding down its quantitative easing programme which has weighed on borrowing costs and, in turn, on bank margins. There are complications as to when this signal may come, given a number of political risk events on the calendar all the way to February 2018, which may keep the ECB cautious. Even so, forecasts that overall earnings will grow by as much as 32% in Q2, and 19.1% in Q3, point to continuing optimism overall, even if the outlook for lenders remains constrained.
As a whole, 62% of STOXX 600 financials (including banks) beat forecasts in Q1, with growth of 95.1% foreseen in Q2, after a 25% rise in Q1. As per the U.S., energy is turning out to be Europe's best-performing sector in percentage terms, with an 103% rise, for similar reasons as in the states. Mining firms are close behind, looking set to grow earnings by 40%, as that industry, like oil, ruthlessly cuts costs and ups efficiency to juice a moderate bounce of commodity prices.
What use utilities?
The weakest European sector in Q1 is utilities, where earnings are tracking 30% lower. Growth is being crimped as huge consumer energy firms like RWE, EDF and Centrica are hit by a combination of expected or actual increases in the regulatory burden, such as price caps and, in Germany, costs from a tortuous deconstruction of the nuclear energy infrastructure. Meanwhile, many smaller STOXX sub sectors suffer from the same issue as the S&P 500’s Telecom Services index.
Elsewhere in Europe, a more modest growth rate among UK companies looks weak compared to rip-roaring gains on the continent. Reuters data shows an aggregate earnings contraction of 17.9% is expected in the UK once ongoing quarterly reporting is complete. It’s worth remembering however that under British reporting conventions relatively few large firms actually disclose profits every quarter. Most companies report earnings twice-yearly, only releasing sales results each quarter.
Among well-covered UK companies with a market cap of more than £10bn, earnings expectations for the year are highest for miners Rio Tinto and Anglo American. Their profits are forecast to grow 5%-7%. Building materials firms Wolseley and CRH are next, with annual earnings forecast to rise about 2% on the year.
Indeed, miners are again expected to lead for the year in terms of profit growth among London's largest 350 listed firms, as shown by the graphic below. Energy producers are seen as close behind, whilst utilities are forecast to keep lagging.
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