Silver lining tailwind effect
With third quarter reporting nearly concluded, S&P 500 companies are delivering growth rivaling post-recession 2010. Not surprisingly, valuations are also breaking records. Meanwhile, record margins present more challenging hurdles to 2018 growth.
On August 21, the Great American Solar Eclipse will trace a “path of totality” across the continental United States. Allegorically, expectations of accelerated earnings growth may become eclipsed by looming comparable earnings hurdles at already elevated stock market valuations.
Companies are finally turning performance from “worst-since” to “best-since” while wrestling rising hurdles in a radically changing environment. Expectations have risen to over 20% growth, much of which markets have priced-in at peril of a more serious correction.
Like Shakespeare’s plays, markets are human nature on display. Expectations become extended with rallies as the best outcomes are priced-in. But in protracted corrections, hope ebbs as the worst outcomes are discounted. Today’s market is where “oft expectations fail”.
US companies face unrealistically high expectations for 2017 earnings growth, while contending with stock prices which have jumped ahead to record levels. Markets don’t react well when priced-in expectations disappoint.
Winds of change have swept across the geopolitical landscape from 2016 and into the new year. How markets will be affected in 2017 and beyond will be the focus of much speculation. At Coherent, we would rather rely on tangible market factors more easily observable than wind.
After a rough start, 2016 appears to be headed into a good close for equity markets. In this last 2016 issue of the Coherent Investor series, we review possibilities for 2017 earnings. We consider variables from three perspectives, fundamental market drivers such as sales and margins, cyclical and seasonal factors, and finally economic conditions.
In earlier articles, I introduced the “silver lining for 2016.” The further 2015 earnings declined, the lower the bar became for realizing a positive 2016 earnings growth rate. Third quarter earnings look to become the first growth we have seen in nearly two years. This silver lining has finally arrived, but not without its caveats.
First quarter 2016 earnings expectations as of the end of April are for yet another quarter of sales and earnings contraction. Excessive optimism has been a consistent theme for more than a year. Is it possible for the market to grow the estimated 15% by year end?
It’s been a tumultuous period since September 2014 when the first crack appeared in the bull market which started in 2011. One year later, the August 2015 tremors would confirm a market that had topped and was correcting. The January aftershocks squelched any remaining euphoria evident in the preceding October rally.