2Q Corporate Results: 2% Earnings Growth Expected in 2019

Summary: Overall, corporate results in the second quarter of 2019 were fine, but growth has slowed. Sales and earnings were up were 5% and 4% yoy, respectively. Margins rebounded from the end of 2018 but are still below the cycle high made in 3Q18.

Looking ahead, analysts' expectations for 10% earnings growth in 2019 have been revised down to just 2%. This estimate will be about right if margins can be maintained at the current level and the dollar doesn't further appreciate, but another drop in oil prices could cause earnings growth to decline towards zero.

For 2020, analysts currently expect growth of 5% to sales and 11% to earnings. This is too optimistic. Assuming no change in the dollar, oil and margins, earnings growth is likely to be halved. Margin compression (likely) would lower growth much more.

Valuations are now back to their 25-year average. They are not cheap, but if investors once again become ebullient, there is room for valuations to expand. With earnings growth likely to be negligible, the key for share price appreciation in 2019 (and 2020) is likely to hinge almost entirely on valuations expanding.

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93% of the companies in the S&P 500 have released their second quarter (2Q19) financial reports. The headline numbers were fine, but growth has slowed. Here are the details:


Sales

Quarterly sales grew 5% over the past year, to a new all-time high (ATH). On a trailing 12-month basis (TTM), sales were 7% higher yoy (all financial data in this post is from S&P). Enlarge any image by clicking on it.

1Q Corporate Results: 3% Earnings Growth Expected In 2019

Summary: Overall, corporate results in the first quarter of 2019 were good, but not great. Sales and earnings growth were 6% and 8%, respectively. Margins rebounded from the end of 2018 but are still below the cycle high made in 3Q18.

Looking ahead, analysts' expectations for 10% earnings growth in 2019 have been revised down to 3%. This estimate will be about right if margins can be maintained at the their 1Q19 level, but if the dollar continues to appreciate, earnings growth could be close to zero and another drop in oil prices could cause earnings to decline.

Valuations are now back to their 25-year average. They are not cheap, but if investors once again become ebullient, there is room for valuations to expand. With earnings growth likely to be negligible, the key for share price appreciation in 2019 is likely to hinge almost entirely on valuations expanding.

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96% of the companies in the S&P 500 have released their first quarter (1Q19) financial reports. The headline numbers were good, but not great. Here are the details:


Sales

Quarterly sales grew 6% over the past year. On a trailing 12-month basis (TTM), sales were 8% higher yoy, a strong result (all financial data in this post is from S&P). Enlarge any image by clicking on it.

4Q Corporate Results: Margins Fall. A Watch Out for 2019

Summary: Overall, corporate results in the fourth quarter of 2018 were good, but not great. S&P sales grew 6% and earnings rose 32%, but profit margins fell to 10.9% from a high of 12.1% in the third quarter. This was the first substantial fall in margins since the "profit recession" in 2015.

Fundamentals have been driving the stock market higher, not valuations: earnings during the past 1 year and 2 years have risen faster than the S&P index itself (meaning, valuations contracted). The strong growth in company profits is not due to a net share reduction (e.g., buybacks) either.

Looking ahead, expectations for 10% earnings growth in 2019 have already been revised down to 5%. This still looks too optimistic: if margins in 2019 remain at the same level as in 4Q18, then earnings growth will be 0%. Dollar appreciation and declining oil prices are additional headwinds that could cause earnings to fall this year.

Valuations are now back to their 25-year average. They are not cheap, but the excesses from early 2018 have been worked off: if investors once again become ebullient, there is room for valuations to expand. However, with earnings growth likely to negligible, the key for share price appreciation in 2019 is likely to hinge entirely on valuations expanding.

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85% of the companies in the S&P 500 have released their fourth quarter (4Q18) financial reports. The headline numbers were good, but not great. Here are the details:


Sales

Quarterly sales reached a new all-time high, growing 6% over the past year. On a trailing 12-month basis (TTM), sales are 9% higher yoy, among the best growth in 12 years (all financial data in this post is from S&P). Enlarge any image by clicking on it.

3Q Corporate Results Were Great. The Outlook for 2019 Looks Far Too Optimistic

Summary: Overall, corporate results in the third quarter were excellent. S&P sales grew 11%, earnings rose 30% and profit margins expanded to a new all-time high of 12.2%.

Fundamentals have been driving the stock market higher, not valuations: earnings during the past 1 year and 2 years have risen faster than the S&P index itself (meaning, valuations contracted). The strong growth in company profits is not due to a net share reduction (e.g., buybacks) either.

Looking ahead, expectations for 10% earnings growth in 2019 looks far too optimistic and will likely be revised downward as the substantial jump in margins this year is unlikely to continue. Even maintaining these margins will be a stretch, and earnings are at risk of falling. Dollar appreciation and declining oil prices are additional headwinds.

Valuations are now slightly below their 25-year average. They are not cheap, but the excess from early 2018 has been worked off. If investors once again become ebullient, there is room for valuations to expand. With earnings growth at risk, the key for share price appreciation in 2019 is likely to hinge on valuations expanding.

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90% of the companies in the S&P 500 have released their third quarter (3Q18) financial reports. The headline numbers are very good. Here are the details:


Sales

Quarterly sales reached a new all-time high, growing 11% over the past year. On a trailing 12-month basis (TTM), sales are 10% higher yoy, the best growth in 12 years (since 2006; all financial data in this post is from S&P). Enlarge any image by clicking on it.

2Q Corporate Results: All-Time High Sales, Profits and Margins

Summary: Overall, corporate results in the second quarter were excellent. S&P sales grew 11%, earnings rose 27% and profit margins expanded to a new all-time high of 11.4%.

Fundamentals are driving the stock market higher, not valuations: earnings during the past 1 year and 2 years have risen faster than the S&P index itself. The strong growth in company profits is not due to the net reduction in shares through, for example, corporate buybacks.

The outlook in 2018 looks solid: the consensus expects earnings to grow 21% this year. Rising energy prices and the tax reform law are tailwinds.

Expectations for 10% earnings growth in 2019 looks too optimistic and will likely be revised downward;  the substantial jump in margins this year is unlikely to be sustained, especially with labor and interest expenses rising.

Valuations are back to their 25-year average. They are not cheap, but the excess from 2017 and early 2018 has been worked off. If investors once again become ebullient, there is room for valuations to expand.

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90% of the companies in the S&P 500 have released their second quarter (2Q18) financial reports. The headline numbers are very good. Here are the details:


Sales

Quarterly sales reached a new all-time high, growing 11% over the past year, the best sales growth in 7 years (since 2011). On a trailing 12-month basis (TTM), sales are 9% higher yoy (all financial data in this post is from S&P). Enlarge any image by clicking on it.

Time To Not Freak Out About Debt Again

Summary: Debt is a perennial worry.  It's a natural human tendency to think of debt as bad, that by incurring debt we are living beyond our means. But much of what you hear about debt in the US is hyperbole. Here are the facts:

Household debt has fallen in the aftermath of the Great Recession: on a per capita basis, it's back to the same level as 14 years ago. Households' debt relative to their net worth is as low now as in 1985. For all the consternation about the threat posed by student loans, their default rates are actually falling.

Corporate leverage today is not materially different than it was in 1993 or 2003, i.e., early in two expansion cycles. The delinquency rate on corporate loans is lower than at any time during the prior three expansion cycles. High yield spreads are falling and default rates are well below average.

The "tax reform" bill signed in 2017 is forecast to further expand the federal debt.  But examples from around the world do not show a strong correlation between federal debt and economic growth over the next 5-10 years. For all the hand wringing about high federal debt, the interest cost of that debt is just 1.3% of GDP, as low as during the halcyon days of Eisenhower and Elvis.

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Like most people, you're probably worried about the amount of debt in the US.  We seem to be going broke. Enlarge any chart by clicking on it.

1Q Corporate Results Were Excellent, But Margins May Be Peaking

Summary: Overall, corporate results in the first quarter were very good. S&P sales grew 10%, earnings rose 24% and profit margins expanded to a new all-time high of 11.6%.

Fundamentals are driving the stock market higher, not valuations: earnings during the past 1 year and 2 years have risen faster than the S&P index itself.

The outlook in 2018 looks solid right now: the consensus expects earnings to grow 19% this year. Rising energy prices and the new tax reform law are tailwinds.

Expectations for 9% earnings growth in 2019 will probably to be revised downwards;  the substantial jump in margins this year is unlikely to be sustained, especially with labor and interest costs rising.

With the correction in equities over the past 3 months, valuations are back to their 25-year average. They are not cheap, but the excess from 2017 and early 2018 has been largely worked off. If investors once again become ebullient, there is room for valuations to expand.

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84% of the companies in the S&P 500 have released their first quarter (1Q18) financial reports. The headline numbers are very good. Here are the details:


Sales

Overall quarterly sales are 10% higher than a year ago, the best sales growth in 6 years (since 2011). On a trailing 12-month basis (TTM), sales are 8% higher yoy (all financial data in this post is from S&P). Enlarge any image by clicking on it.

Interview With Financial Sense on What To Look For Ahead of an Equity Market Peak

We were interviewed by Cris Sheridan of Financial Sense on March 13th. During the interview we discuss the macro-economic environment, the housing market, current market technicals and the financial performance of US companies. One theme of our discussion is what to look for ahead of the next bear market in US equities. Another theme is a potentially bullish set up for US treasuries over the next several months.

Our thanks to Cris for the opportunity to speak with him and to his editor for making these disparate thoughts seem cogent.

Listen here.

If you find this post to be valuable, consider visiting a few of our sponsors who have offers that might be relevant to you.

Earnings Growth Matched The Rapid Pace of Equity Appreciation in 2017

Summary: S&P sales grew 9% over the past year, the best growth in 6 years. Earnings rose 23%, the best growth in 7 years. Profit margins expanded to a new all-time high of 10.8%. Overall, corporate results in the fourth quarter were very good. Earnings during 2017, in fact, rose as much the SPX index itself.

The outlook for 2018 appears to also be strong. "Baseline" economic growth is about 4-5%. The dollar is depreciating, which could add another 3 percentage points to growth. The new tax reform law, passed in late 2017, is expected to add another 7 percentage points. Finally, rising oil prices are a tailwind for the energy sector. As a consequence, the consensus expects earnings to grow 18% this year.

Where critics have a valid point is valuation: even excluding energy, the S&P is now more highly valued than anytime outside of the late 1990s. With profit margins already at new highs, it will likely take excessive bullishness among investors to propel equity price appreciation faster than earnings over the next few years.

Bearish pundits continue to repeat several misconceptions. In truth, 90% of the growth in earnings in the S&P over the past 8 years has come from better profits, not share "buybacks." The S&P's price appreciation has been primarily driven by better earnings (60%) not higher valuations (the remaining 40%). The trend in "operating earnings" is the same as those based on GAAP.

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86% of the companies in the S&P 500 have released their fourth quarter (4Q17) financial reports. The headline numbers are very good. Here are the details:


Sales

Overall quarterly sales are 9% higher than a year ago. This is the best sales growth in 6 years (since 2011). On a trailing 12-month basis (TTM), sales are 7% higher yoy (all financial data in this post is from S&P). Enlarge any image by clicking on it.

Solid Sales Growth and Margins At New Highs Drive 3Q17 Results

Summary: For the third quarter (3Q17), S&P earnings rose 12% yoy, sales grew 6% and profit margins expanded to new all-time highs.

These strong results are not due to the rebound in oil prices. Sales for the sectors with the highest weighting in the S&P have grown an average of 7% in the past year and 19% in the past 3 years. Moreover, margins outside of energy have expanded to a new high of 10.8%.

Bearish pundits continue to repeat several misconceptions: that "operating earnings" are deviating more than usual from GAAP measurements; that share reductions (buybacks) are behind most EPS growth; and that equity gains are unreasonably out of proportion to earnings growth. None of these are correct. Continued growth in employment, wages and consumption tell us that corporate financial results should be improving, as they have in fact done.

Where critics have a valid point is valuation: even excluding energy, the S&P is now more highly valued than anytime outside of the late 1990s technology bubble. With economic growth of 4-5% (nominal) and margins already at new highs, it will take excessive bullishness among investors to propel S&P price appreciation at a significantly faster rate. At this point, lower valuations are a notable risk to equity returns.

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92% of the companies in the S&P 500 have released their 3Q17 financial reports. The headline numbers are good. Overall sales are 6% higher than a year ago, the second best growth rate in nearly 6 years. Earnings (GAAP-basis) are 12% higher than a year ago. Profit margins are at a new high of 10.2%, exceeding the prior peak from 2014.

Before looking at the details of the current reports, it's worth addressing some common misconceptions that are regularly cited.

First, financial reports are said to be fake. This complaint has been a feature of every bull market since at least the 1990s. In truth, the trend in GAAP earnings (red line) is the same as "operating earnings" (blue line; all financial data in this post is from S&P). Enlarge any image by clicking on it.

Interview With Financial Sense on Identifying the Next Bear Market

We were interviewed by Cris Sheridan of Financial Sense on August 24th. During the interview we discuss current market technicals, the macro-economic environment, the investor sentiment backdrop and the prospect for future equity returns. One theme of our discussion is what to look for ahead of a bear market in US equities. Another theme is how the current period of low volatility will likely resolve.

Our thanks to Cris for the opportunity to speak with him and to his editor for making these disparate thoughts seem cogent.

Listen here.

If you find this post to be valuable, consider visiting a few of our sponsors who have offers that might be relevant to you.

Profit Margins Expand to New Highs to Boost 2Q17 Results

Summary: The headline numbers for 2Q17 financial reports are good: S&P profits are up 19% yoy; sales are 6% higher; profit margins are at new highs. This is in stark contrast to early 2016, when profits had declined by 15% and most investors expected a recession and a new bear market to be underway.

These strong results are not due to better oil prices. Sales for the sectors with the highest weighting in the S&P have grown an average of 9% in the past year. Moreover, margins outside of energy have expanded to 10.8%, a new high.

Bearish pundits continue to repeat claims that are more than 20 years old: that "operating earnings" are deviating more than usual from GAAP measurements, and that share reductions (buybacks) are behind most EPS growth. These are both wrong. Continued growth in employment, wages and consumption tell us that corporate financial results should be improving, as they have in fact done.

Where critics have a valid point is valuation: even excluding energy, the S&P is now more highly valued than anytime outside of the 1998-2000 dot com bubble. With economic growth of 4-5% (nominal) and margins already at new highs, it will likely take excessive bullishness among investors to propel S&P price appreciation at a significantly faster rate.

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84% of the companies in the S&P 500 have released their 2Q17 financial reports. The headline numbers are good. Overall sales are 6% higher than a year ago, the second best growth rate in more than 5 years. Earnings (GAAP-basis) are 19% higher than a year ago. Profit margins are at new highs of 10.3%, exceeding the prior highs from 2014.

Before looking at the details of the current reports, it's worth addressing some common misconceptions regularly cited by bearish pundits.

First, are earnings reports meaningfully manipulated? This concern has been echoed by none other than the chief accountant of the SEC, who has complained about non-GAAP earnings numbers being "EBS", or "everything but bad stuff." Enlarge any image by clicking on it.

Better Sales And Profit Growth Are Behind Good 1Q17 Results, Not Financial Engineering

Summary: S&P profits are up 22% yoy. Sales are 7.2% higher. By some measures, profit margins are at new highs. This is in stark contrast from a year ago, when profits had declined by 15% and most investors expected a recession and a new bear market to be underway.

Bearish pundits continue to repeat claims that are more than 20 years old: that "operating earnings" are deviating more than usual from GAAP measurements, and that share reductions (buybacks) are behind most EPS growth. These are both wrong. Continued growth in employment, wages and consumption tell us that corporate financial results should be improving, as they have in fact done.

Where critics have a valid point is valuation: even excluding energy, the S&P is now more highly valued than anytime outside of the 1998-2000 dot com bubble. With economic growth of 4-5% (nominal), it will likely take excessive bullishness among investors to propel S&P price appreciation at a significantly faster rate.

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A little over 60% of the companies in the S&P 500 have released their 1Q17 financial reports. The headline numbers are good. Overall sales are 7.2% higher than a year ago, the best annual rate of growth in more than 6 years. Earnings (GAAP-basis) are 22% higher than a year ago. Profit margins are back to their highs of nearly 10% first reached in 2014.

Before looking at the details of the current reports, it's worth addressing some common misconceptions regularly cited by bearish pundits.

First, are earnings reports meaningfully manipulated? This concern has been echoed by none other than the chief accountant of the SEC, who has complained about non-GAAP earnings numbers being "EBS", or "everything but bad stuff." Enlarge any image by clicking on it.

The Similarities (and Key Differences) Between 2017 and 2013 So Far

Summary: 2017 is off to a remarkably similar start to 2013. No two years are ever exactly the same, so there's no reason to suggest that 2017 will repeat the 30% gains achieved in 2013. But many of the technical and fundamental similarities between these years suggest that 2017 may continue to be a good year.

There are two watch outs, however, that make 2017 much higher risk than 2013. It's also worth recalling that equities fell 3-8% at six different points in 2013. Expecting 2017 to continue to ride smoothly higher will probably prove to be a mistake.

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2017 is off to a remarkably similar start to 2013. Is it set to be a repeat of that year? It's an important question as stocks gained about 30% in 2013.

Consider some of the following:

2017, like 2013, is the first year in a new Presidential term.

Both years got off to a fast start. By March, SPX had gained 8% in both 2013 and 2017.

Both years started by making a string of new all-time highs (ATHs). By the end of February, the Dow Industrials had closed at a new ATH 12 days in a row. A similarly rare streak of 10 days took place by March 2013.

SPX is often weak in February. But the index gained in both January and February in 2013 and 2017. In the other instances that this has happened since 1945, SPX closed up for the full year every time by an average of 24% (more on this here).

Both 2013 and 2017 came on the heels of long, volatile periods. SPX dropped 20% in 2011 and started 2013 only  2% higher than 18 months earlier. Similarly, SPX dropped 16% in 2016 and started 2017 only 5% higher than 18 months earlier. In both years, a dip at the election in November caused the market to be oversold; in both years, the market was significantly overbought by March (top panel).

Sales and Earnings Back At Highs, But So Are Valuations

Summary: In the past year, S&P profits have grown 46% yoy. Sales are 4.5% higher. By some measures, profit margins are back at their prior highs. This is a remarkable turnaround from a year ago, when profits had declined by 15% and most investors interpreted this as a sure sign that a recession and a new bear market were underway.

The critics were wrong because they confused a collapse in one sector - energy, where sales dropped by 60% - with a general decline in all sectors. But in the past two years, sales in the other sectors have continued to grow and margins have mostly remained strong. A rebound in oil prices (and only modest appreciation of the dollar, another headwind in the past two years) bodes well for forward sales and earnings growth.

Where critics have a valid point is valuation: even excluding energy, the S&P is now more highly valued than anytime outside of the 1998-2002 dot com bubble. Valuations rise with investor sentiment; that sentiment is now very bullish. With economic growth of 4-5% (nominal), it will likely take outright exuberance among investors to propel S&P price appreciation at a significantly faster rate.

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A year ago, profits for companies in the S&P had declined 15% year over year (yoy). Sales were 3% lower. Margins had fallen more than 100 basis points. The consensus believed all of this signaled the start of a recession in the US.

These dire prognoses for the US have not worked out. Jobless claims are at more than a 40 year low (first chart below) and retail sales are at an all-time high. US demand growth, measured a number of different ways, has been about 4-5% nominal yoy during the past two years (second chart below). There has been no marked deterioration in domestic consumption or employment.

What Happened To The Earnings Recession?

Summary: A year ago, profits for companies in the S&P had declined 15% year over year (yoy). Sales were 3% lower. Margins had fallen more than 100 basis points. The consensus believed all of this signaled the start of a recession in the US.

How has that dire prognosis worked out? In a word: terrible. Jobless claims are at more than a 40 year low and retail sales are at an all-time high. The US economy continues to expand.

In the past year, S&P profits have grown 12% yoy. Sales are 2.4% higher. By some measures, profit margins are at new highs. Why were the critics wrong? They confused a collapse in one sector - energy, where sales dropped by 60% - with a general decline in all sectors. Energy was considered the same as financials in 2007-08; events since then show that it is nothing like financials.

Where critics have a valid point is valuation: even excluding energy, the S&P is highly valued. With economic growth of 3-4% (nominal), it will likely take exuberance among investors to propel S&P price appreciation at a significantly faster annual clip.

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A year ago, profits for companies in the S&P had declined 15% year over year (yoy). Sales were 3% lower. Margins had fallen more than 100 basis points. The consensus believed all of this signaled the start of a recession in the US.

The chart below was from Barclays at the start of the 2016, who said that big drops in profitability like those last year have coincided with a recession 5 of the last 6 times since 1973 (read further here). Enlarge any chart by clicking on it.

Interview with Financial Sense on US Macro and Equities

We were interviewed by Cris Sheridan of Financial Sense on September 21, the day of the FOMC rate decision. During the interview, we discuss the good and the not so good within the macro environment, the Fed, corporate fundamentals, investor positioning and what all of this means for US equities in the months ahead.

Our thanks to Cris for the opportunity to speak with him and to his editor for making these disparate thoughts seem cogent.

Listen here.

If you find this post to be valuable, consider visiting a few of our sponsors who have offers that might be relevant to you.

Are Poor Sales and Profit Growth Signaling an Imminent Recession?

Summary: Over the past year, earnings for the S&P have declined 12%. Earnings have declined 5 quarters in a row. Even excluding the troubled energy sector, valuations now are as high (or higher) than in 2007. It's no wonder that there has been little net gain in the S&P since late 2014.

Does the dire state of corporate sales and profit growth signal an imminent recession?

The decline in sales growth that started in 3Q14 corresponds with both the start of a 75% drop in the price of energy as well as the start of a 20% appreciation in the dollar. Currency effects aside, the sales and profits for the majority of sectors are not weak.  Moreover, parallels to the 2000 tech bubble and the 2007 financial bubble are largely without merit. On balance, corporate sales and profit growth are most likely not signaling an imminent recession.

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About 90% of the S&P has reported earnings for 1Q16. And, very simply, these reports are bleak, showing declining sales and declining profits:

Sales fell 2% yoy on a trailing 12-month basis (TTM), the third quarter in a row that sales have fallen.

Earnings per share (TTM, GAAP-basis) declined by 12% yoy, the fifth quarter in a row that profits have fallen. Unless otherwise stated, all data in this post is from S&P (enlarge any image by clicking on it).

The Truths And Myths of Buybacks

Summary: It's true that corporations buying their own shares (buybacks) represents a large source of demand for equities and have helped push asset prices higher.

But much of what is believed about buybacks is a myth. There is much more to share appreciation than buybacks. EPS growth is overwhelmingly driven by higher profits, not share reduction. Buybacks are not a result of ZIRP or QE. Companies are not, as a whole, under investing in manufacturing or R&D or other sources of future growth because of buybacks.

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Buybacks are widely vilified and greatly misunderstood. This post will try to separate the facts from the myths.

It's true that buybacks represent a large amount of money. In the past 12 months, companies have spent $555b on buybacks. Over the past 3 years, over $1.5t has been spent on buybacks. This is a lot of money (data below and elsewhere in this post from Yardeni).

3Q Financials Were Poor; 4Q Won't Be Better. What To Expect in 2016

Summary: 3Q financials have been predictably poor, with negative growth in both sales and EPS. Sales growth has been affected by a 50% fall in oil prices and 15% rise in the trade-weighted dollar. Both of those are likely to make upcoming 4Q financials look bad as well.

Of note is that overall profit margins expanded slightly, even with negative margins for energy stocks.

Looking ahead to 2016, at $45-50, oil prices will no longer negatively affect sales and EPS growth. Year over year changes in the dollar may also become negligible starting in 2016.

In fact, the biggest wildcard is the dollar, which historically weakens after interest rates start rising. This would be a boon to the roughly 40% of S&P sales and profits that are derived from overseas.

A return to 4% growth is not an unreasonable expectation for 2016.

Especially for their rate of growth, S&P valuations are high. Even if sales and EPS growth start to pick up, valuations are likely to remain a considerable headwind to equity appreciation in 2016.

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About 88% of US corporates have reported their financial results for the 3rd quarter of 2015. What have we learned?


Earnings: Large impact from oil price drop

Using figures from FactSet, EPS growth in 3Q is tracking minus 2.2% (year over year); sales growth is tracking minus 3.5%.  Both EPS and sales growth are poor.

By now it should be no surprise that the energy sector has been hard hit by falling oil prices. The average price of oil was nearly $100 in the 3Q of 2014; it fell 50% to an average of roughly $50 in 3Q of 2015.