Extraordinary Earnings Louder Than Trump
When companies report earnings, they adhere to Generally Accepted Accounting Principles (GAAP). Stock market analysts make adjustments to GAAP earnings to exclude “extraordinary items.” The analysts are trying to uncover the fundamental earnings trends by making these adjustments. Adjusted earnings are called “operating earnings.”
When we look at operating earnings rather than GAAP earnings, we see some extraordinary things. For instance, operating earnings expectations for the fourth quarter 2016 are for a year-over-year increase of 32%, a rate not seen since late-2010 when earnings were rebounding in the wake of the financial crisis.
After seven consecutive down year-over-year quarters lasting from the fourth quarter 2014 through the second quarter 2016, earnings are reaccelerating.
The seven negative growth quarters of operating earnings helps explain why the S&P 500 was roughly 2085 in December of 2014 and was still at this level on November 4, 2016.
The green arrow on the graph above shows that we are just now reaching the point when we should expect to see record S&P 500 operating earnings achieved in all four quarters of 2017. Analysts are forecasting a 22% increase in operating earnings year-over-year and a 36% rise over the next two calendar years from 2016 levels.
So far during this earnings season with over ten percent of all companies having reported, 67% of the companies that have already reported have posted better than expected earnings numbers.
Of the 30 stocks in the Dow Jones Industrial Average, 18 reported earnings through the close yesterday with nearly 80% exceeding earnings estimates. The average beat rate of the 18 companies is nearly 6%.
We are early in the earnings reporting period but it appears the high S&P 500 earnings growth outlook may be transitioning from forecast to reality as the numbers are generally coming in better than expected.
Since just before the presidential election on November 4 2016, the S&P 500 is up about 10%. If the 22% increase in operating earnings translates directly into a 22% potential increase in the value of the S&P 500, the target valuation of the S&P 500 during 2017 would be roughly 2,540 or another 10% higher.
This week, the Leading Economic Index (LEI) was updated. For December, the LEI increased by 0.5% and the November report was revised higher to 0.1% from 0.0%. The six-month moving average change in the LEI is now 0.2%. The LEI is showing no signs of intermediate-term recession risk.
With no recession in sight and a potential 10% additional rise in stock market values by year end, the risk/reward balance remains attractive for U.S. stock investors. Give us a call if you would like to discuss how best to invest in 2017.
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This commentary and previous editions are available as PDFs:
1/27/2017: Extraordinary Earnings Louder Than Trump
1/20/2017: It's Not All About Trump
1/13/2017: I Gotta Feeling
1/6/2017: Finally, A Case for International in Your Portfolio
12/30/2016: Predicting the Future -2017
12/23/2016: Bullish New Year
12/16/2016: All I Want For Christmas is Financial Independence
12/9/2016: Debt Trap
12/2/2016: Trade What Is, Not What You Think It Should Be – 2017 Outlook
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