“Prediction is very difficult, especially if it’s about the future.”
– Nils Bohr, Nobel laureate in Physics
I don’t think Bohr was referencing corporate earnings estimates when he made the above quip, but his words do make a point about predicting the future…
When discussing the state of the U.S. economy, one of the things analysts often point to is the health of corporate earnings – not just reported earnings, but future earnings.
In the years since the financial crisis future earnings estimates have tended to start out relatively high, then as the year progresses those estimates decline – in other words, analysts and company management start the year fairly optimistic then rein in that optimism throughout the year. The chart below shows this dynamic over the past 5 calendar years:
In 4 of the past 5 years, earnings estimates have declined from where they started the year. In two of those years estimates eventually ticked positive, but the increase was nothing to write home about. 2018 has been a different story. According to Factset the estimated Q2 earnings growth rate for the S&P 500 is +19.0%, which would mark the second highest growth rate since Q1 of 2011. The blue line above shows estimates increasing even on the back of those impressive Q2 numbers. This is a big change from years past (the average change in estimates in the years 2013 – 2017 was -1.2%). While we still have 6 months left in the year, the near-term future looks promising.
Could All This be a Temporary Stimulus from the Tax Cuts?
There is no doubt that the recent tax cuts have provided a boost to both reported and future earnings. But we don’t think this is the only reason businesses are growing. Take a look at the chart below from Goldman. Revenues are growing as well.
Revenues are above the line, i.e. before taxes, and not affected by tax policy. Goldman’s estimates are that 2018 S&P 500 revenues will grow by nearly 10%, building on growth of 7% in 2017. This revenue growth is also broad based with all 11 sectors of the S&P reporting positive year-over-year growth, four of which anticipate revenues growing by double digits (see here). Similar to earnings, if this growth rate holds it will be the highest revenue growth since Q3 of 2011. What we’re trying to say is that because revenues are also growing at a solid pace, the earnings picture can’t just be because of the tax cuts.
What’s the Catch?
So what’s the catch? Well, earnings estimates can obviously be wrong (just ask Nils Bohr), and at some point growth will slow. The chart below from Goldman shows the rosy 2018 scenario we outlined above. 2019 growth estimates are then cut in half and 2020’s number is even lower. The main takeaway from this chart is that we shouldn’t expect 2018 growth to continue into 2019 and beyond.
So corporate earnings growth is good. And it seems like it may stay good through at least the end of 2018. With earnings growth being an obvious component of equity returns, this bodes well for helping to provide a floor under stock market returns. As Mr. Bohr would tell you however, estimates aren’t facts, and those estimates can change on a dime.
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