Corporate earnings season is almost over in the US and what companies have said about how much money they’ve made shines a light on the direction of the market, because corporate profitability is the main driver of stock prices.
And so far, helped by a favourable business environment and no signs of a recession, the direction of corporate earnings growth is reflected (albeit somewhat giddily in the price of some) in stock prices and its across a broad number of sectors.
Runaway tech sector is an example, Google and Amazon both traded at over a $1,000 per share in June and July 2017 respectively.
Stocks are currently expensive by any barometer of measure. Not just in the US, in Europe corporate earnings growth was seen as "running neck and neck with the healthy clip seen in the US" according to Reuters.
As in the US, Europe’s corporate earnings growth is against an improving economic backdrop. Confidence in future growth of European equities was underpinned by 25% profit growth for first quarter 2017 according to the FT.
Global scene looks good for corporate earnings
There are a number of theories for why the stock markets are hitting such highs. Thus far, in the context of economic and profit growth experts see justification in those prices and further, going forward there is an expectation of improving and accelerated earnings growth.
In October 2015, the Harvard Business Review described the exceptional favourable economic environment for the largest North American and European multinational corporations.
It claimed they had enjoyed "their longest and strongest run of rising profitability in the post-war era, thanks to an environment that has supported robust revenue growth and cost efficiencies."
According to HBR, since the 1980s corporate profits had surged to increase their share of GDP by 30%. In 1980, corporate profits grew from $2.0bn and 7% of GDP to $7.2bn and 9.8% of GDP.
Underscoring the health of corporate earnings, this season has seen the third consecutive quarter of earnings growth in the US. Brighter forecasts across the world for India, China for example, means that multinationals like McDonalds and Boeing are benefitting from a falling dollar
Up but only for so long
In Europe, it is hoped that second-quarter earnings will boost European equities which is seen as a laggard to the US.
Jonathan Stubbs, a strategist at Citigroup said recently in the FT in, "if second-quarter European earnings do deliver the double-digit profit growth that analysts forecast, it will keep the region’s companies on course for the first full year of earnings expansion for six years."
US corporates are in a sublime moment, which commentators call the “Goldilocks” environment. Goldman Sachs described the current climate as "Steady growth and a patient Fed represent a Goldilocks scenario for US equities.
Growth data has not been too cold, supporting S&P 500 EPS growth of 14% in 1Q and consensus expectations for 11% in 2017.
“Nor have conditions run too hot, causing a rise in bond yields that we expected would constrain equity valuations this year. The economic environment has proven just right..."
Investors look for ways to pierce their bubble
Of the more than 90% of S&P 500 companies already reported for the Q2 2017 season FactSet found that: "Of these companies, 73% have reported actual EPS above the mean EPS estimate, which is above the five-year average of 68%.
In aggregate, earnings have exceeded expectations by 6.1%, which is also above the five-year average of 4.1%. Due to these upside surprises, the earnings growth rate for the S&P 500 has improved to 10.2% today from 6.4% on June 30."
It would be natural to think that companies producing such an upside surprise would expect to be rewarded by a similarly upward trajectory in share price. But investors as the WSJ points out “are raising the bar for what’s enough to propel stocks higher.”
Companies in the S&P 500 that reported positive earnings surprises for the quarter actually saw a decrease in share price of -0.3% from an average two days prior to reporting actual results through two days following according to FactSet.