by Brad M. Weafer, CFA, Chief Investment Officer
At Thanksgiving dinner last week, my wife asked the kids what they are most thankful for. My daughters gave the proper answer of course (they take after their Mom) and suggested things like family and friends. For my part, I quipped that I was also thankful for the bull market!
While this was a not so subtle attempt at humor, there was plenty of truth in the statement. The S&P 500 notched a new high this week, giving investors something to cheer about this holiday season. This stands in stark contrast to the general sense of pessimism one would infer after talking with the average investor or financial pundit. Let’s be clear, there is always something to worry about with markets and the financial press loves to sow fear. With the growing influence of the internet and social media it seems easier than ever to find things to be concerned about. In the end, most of those things on the worry list don’t really matter to markets. We must remember, over long-term horizons, company profits are the most important driver for stock prices.
In that context, this year’s market advance becomes much more understandable. With the third quarter reporting season just about done, results continue to be encouraging. With 98% of companies in the S&P 500 having reported, 74% of those companies delivered earnings results that were better than Wall Street analysts had predicted. In aggregate, corporate earnings grew a healthy 6.3% this quarter. This was the fifth straight quarter of year over year growth, following a seven quarter decline streak in 2015 and 2016 (see Figure 1 below). This step change in earnings improvement has likely been the most critical driver for the market’s performance this year. With three quarters reported and only one quarter left to forecast, earnings for the calendar year 2017 are now expected to increase by 10% over 2016. This kind of earnings momentum helps support the double digit return for the S&P this year.
Looking forward, earnings estimates are also solid. For next year, Wall Street analysts predict a second straight year of double digit growth (see estimates below). This would be the first time that has happened since 2010, which had the added benefit of easy comparisons coming out of the last recession. We don’t try to predict earnings for the index, but we would point out that many of the pre-existing conditions needed for solid earnings are currently present. These would include low recessionary risk in the U.S., accelerating GDP globally, low and stable inflation, and loose monetary policy at home and abroad. In addition, these estimates do not include any benefit of changes to the tax code, which would be positive for after-tax profitability and provide economic stimulus.
While the fundamentals are good, there is a risk that expectations are set too high for the entire market. With most measures of valuation elevated relative to historical averages, that risk is amplified. A key factor for successful investing is determining what level of future growth in each individual company’s profits are embedded in prices. It’s these situations where we are also thankful we don’t simply buy the index. While prices continue to move higher in the S&P, there are always compelling investments to find when looking at individual companies which is where we focus.
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.