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Earnings, Business Revenue Growth Fundamentally Strong in Jittery Market

Earnings, Business Revenue Growth Fundamentally Strong in Jittery Market
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Tuesday, 06 February 2018 08:12 AM Current | Bio | Archive

Strategy I: Revenues Growth Rising.

The stock market may or may not have an overvaluation problem. That depends on whether historically low inflation and interest rates justify today’s historically high P/Es, as Joe and I believe.

Of course, if both inflation and interest rates are headed significantly higher, then the recent swoon in stock prices may continue to recalibrate valuation levels lower. In any event, the stock market certainly doesn’t have an earnings problem.

The cut in the corporate income tax has been a big booster for 2018 earnings expectations, as we update in the next section.

While all the focus has been on the tax cut and its positive impact on earnings since the start of this year, revenues growth coincidently has picked up smartly thanks to the strength in the global economy.

It’s hard to believe that the record high of 2872.87 on the S&P 500 on January 26 marked the end of the latest bull market given the quickening pace of revenues growth.

Consider the following:

(1) US business sales. There’s a very high correlation between the y/y growth rates of S&P 500 revenues (a quarterly series) and business sales (a monthly series) (Fig. 1). In Q3-2017, S&P 500 revenues was up 5.0% y/y; in November 2017, business sales (the sum of factory shipments and distributors sales) was up 8.0%. The latter represents that series’ fastest growth since February 2012, thanks in part to the rebound in energy prices. Excluding the revenues of the Energy sector, S&P 500 revenues was up 4.0%, while business sales excluding petroleum rose 6.3% (Fig. 2).

(2) 2018 & 2019 revenues. While industry analysts can estimate the impact of the tax cut on earnings, they can’t do the same for revenues. Yet since the end of last year through the end of January, they boosted their expectations for S&P 500 revenues growth during 2018 from 5.6% to 6.1% (Fig. 3). Simultaneously, they’ve raised their 2019 revenues-per-share estimate by 1.0% since the end of last year.

Are we all supply-side economists now? Is it possible that industry analysts have turned more bullish on revenues because they expect that President Donald Trump’s tax reform measures will boost the economy? More likely is that they are getting guidance from corporate managements indicating that their sales are strong because the global economy is strong.

(3) Forward revenues. Joe and I like to track S&P 500 forward revenues, which is now the time-weighted average of 2018 and 2019 revenues estimates of industry analysts for the S&P 500 (Fig. 4). That’s because this weekly series tracks the trend in the actual S&P 500 quarterly revenues closely. The weekly series has been rising rapidly into record-high territory since September 2016. Over the past year, the same can be said for the forward revenues of the S&P 400 and S&P 600 (Fig. 5).

(4) Global economy. Again, unless industry analysts are all drinking Trump’s supply-side Kool-Aid, their optimism about revenues must mostly reflect the upbeat global economic picture. The day before the market’s tightening tantrum last Friday, strong January manufacturing PMIs were released from around the world. The global M-PMI remained high at 54.4—with the sub-index of the advanced economies edging up to a robust reading of 56.3, while the sub-index for the emerging economies edged down to a still-respectable reading of 51.9 (Fig. 6). Among the advanced economies, M-PMIs for the US (59.1) and the Eurozone (59.6) remained elevated, while Japan’s rose to a recent high of 54.8, and the UK’s edged down to 55.3 (Fig. 7).

Interestingly, the US M-PMI is a relatively good leading indicator of S&P 500 revenues growth (Fig. 8). The former is currently predicting that the latter will remain strong.

Strategy II: TCJA Boosting Earnings Estimates. All the above suggests that the 2018 outlook for earnings was already very good late last year given the strength in the global economy—even before the tax cut. Just prior to the passage of the Tax Cut and Jobs Act (TCJA) on December 22, 2017, industry analysts were estimating that S&P 500/400/600 earnings would grow 11.2%, 14.3%, and 20.6% this year (Fig. 9). Since then, through the February 1 week, they’ve raised their 2018 earnings estimates for the S&P 500/400/600 by $9.00, $5.30, and $2.81 per share, resulting in expected growth rates of 17.3%, 20.8%, and 25.4%.

The estimates for each of the current year’s quarterly earnings for the three market-cap indexes all have been raised significantly (Fig. 10). Double-digit growth rates on a y/y basis are now expected across the board through the end of this year (Fig. 11).

Forward earnings for all three S&P market caps are rising faster than their corresponding forward revenues (Fig. 12). As a result, forward profit margins have soared since the TCJA was passed (Fig. 13). However, during the current earnings season, most company managements have said that they intend to spend some of their tax windfalls in ways that might keep a lid on profit margins.

Strategy III: Effective Tax Rate Math. While the upward revisions in earnings estimates since TCJA passage are impressive, they confirm our view that the effective corporate tax rate was well below the statutory 35% before it was slashed by 40% to 21%. We did the math at the beginning of last week using $7 per share as the earnings windfall to the S&P 500. Let’s update the analysis using $9 per share, which is a 6% earnings windfall. Joe and I estimate that Q4-2017 aggregate earnings for the S&P 500 was $1.2 trillion at an annual rate. So that implies that S&P 500 corporations’ tax bill will be lower by $72 billion this year. Last year, they paid $283 billion in federal corporate income taxes. This implies a 25% cut in the effective tax rate. That’s still a substantial windfall.

Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.

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EdwardYardeni
While all the focus has been on the tax cut and its positive impact on earnings since the start of this year, revenues growth coincidently has picked up smartly thanks to the strength in the global economy.
earnings, business, revenue, growth, strong, market
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2018-12-06
Tuesday, 06 February 2018 08:12 AM
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