by Brad M. Weafer, CFA Chief Investment Officer
Second quarter earnings results did not disappoint, propelling the U.S. Stock Market back to all-time highs.
Last week, the bull market in U.S. stocks that started in the depths of the financial crisis turned 3,453 days old. The S&P 500 Index has gone nine and a half years without suffering a 20% decline, the standard definition of a bear market (although a 19% decline in 2011 came close). This advance marks the longest bull run in market history, passing the great market in the 1990s associated with the dot-com boom and subsequent bust. Since the bottom of the market in March of 2009, stocks have returned over 400% in aggregate. Investors celebrated the occasion this week by pushing the S&P 500 to a new all-time high.
While the longevity of the market’s advance has made for fun newspaper stories, the more relevant market metric to focus on is recently reported second quarter corporate earnings results. More than 97% of S&P 500 companies have released their results. Blended results (combining actual results for companies that have reported and estimated results for companies yet report) imply year-over-year earnings growth of 25.04%¹. This follows the impressive 25.30% growth reported during the first quarter and a significant acceleration from 11% growth in 2017. After-tax profit growth was clearly aided by a reduction in the corporate tax rate, but revenue growth is also accelerating, a notable feat nine years into an economic expansion. The blended year-over-year revenue growth rate for the second quarter stands at 9.9%, the highest rate reported since 2011. Corporate profits are a key driver for stock prices and equity values, so strong recent performance in the stock market should come as no surprise.
Looking forward, growth is expected to continue apace (see Figure 1 below). If second quarter results are any indication, estimates for the rest of 2018 may be conservative. To date, 81% of company’s results exceeded Wall Street estimates. According to FactSet, this is the highest ‘beat’ rate reported since they began tracking data in 2008. Earnings growth will most certainly slow in 2019 as companies lap the change in the corporate tax rate. Still, growth in the U.S. economy (4% reported the most recent quarter) should support further profit growth, currently estimated at 10% year-over-year. Some analysts have argued this slowing momentum is a negative sign for the stock market going forward. Our research however suggests otherwise. Over the last 30 years, there were four instances where the growth rate in earnings contracted significantly but stayed positive the following year. It’s a small sample size, but in all four instances, the S&P 500 finished higher the following year and returned double digits in three of the four instances. This isn’t a prediction but does provide some comfort that the stock market can remain healthy even if earnings growth slows.
Our fundamental views on the U.S. equity market have been consistent. A healthy U.S. economy presents a conducive environment for profit growth. Risks related to international trade, continued political dysfunction in Washington, and elevated valuations are a concern, but the direction of earnings is key and is biased higher. We expect continued momentum and remain constructive on stocks for the year ahead.
¹As reported by FactSet Earnings Insight
Market Commentary Disclaimer: This publication is for informational purposes only and should not be considered investment advice or a recommendation of any particular security, strategy or investment product. The information contained herein is the opinion of Boston Financial Management and is subject to change at any time based upon unforeseen events or market conditions.