Can Wall Street earn its way out of trouble? | BetaShares

Can Wall Street earn its way out of trouble?

BY David Bassanese | 11 April 2018
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Wall Street

With global markets reeling from the risk of a trade war between the United States and China, the imminent US earnings reporting season could be a timely reminder that the market’s underlying fundamentals – so far at least – remain sound.

US Earnings: A bumper quarter in prospect

Contrary to persistent fears, US earnings growth has remained strong over the past year and the outlook still appears bright.  Based on Bloomberg estimates, “forward earnings” for companies in the S&P 500 Index rose by 11% in the twelve months to end-2017.

As evident in the chart below, bullish earnings expectations at the start of 2017 held up fairly well as the year progressed, and there were notable upgrades in January following passage through Congress of the Trump tax cuts.

*Lines represent analyst consensus earnings expectations for each calendar year on a rolling monthly basis. Forward earnings is a weighted moving average of earnings expectations for the current and following calendar year.

Assuming current earnings expectations hold up, S&P 500 forward earnings would rise by around 7.5% between end-March and end-December.  Forward earnings are currently forecast to rise by 11% over 2019.

Against this background, the looming March quarter earnings reporting season seems unlikely to disappoint. According to US research firm FactSet, earnings expectations have actually been upgraded over the course of the quarter by 5.4%, compared with a usual earnings downgrade of around 5%.  Based on current expectations, FactSet estimates US firms in the S&P 500 Index should report earnings around 17% higher than year-ago levels – the highest annual growth rate in seven years.

And while US tax cuts have helped, they’re not the whole story.  A modestly weaker $US, rising oil prices, rising bond yields and solid underlying revenue growth (in the technology sector especially) have also been contributory factors.  Indeed, on a sector basis, the strongest annual earnings growth performance is likely to be in energy (78% earnings growth), materials (40%), technology (22%) and financials (20%).

Source: FactSet

US Valuations: Not yet flashing red

Also boding well for the US market (and hence global markets in general) is the fact that equity valuations – especially given the still relatively low level of bond yields – do not appear in dangerously overvalued territory. As seen in the chart below, the market’s price-to-forward earnings ratio of 16.5 at end-March was broadly in line with what history might suggest, based on the fact that US 10-year bond yields were still only around 2.75%.  Indeed, regression analysis on valuations and interest rates stretching back over 50 years would suggest the market was broadly fair-value at end-March given the level of bond yields.

 

Source: BetaShares

All up, this suggests that provided US bond yields do not rise too far too fast this year – and Trump and China manage to settle their differences regarding trade – the outlook for US equities over the coming year remains fairly positive.

Investors interested in obtaining exposure might be interested to take a look at the BetaShares FTSE RAFI U.S. 1000 ETF (ASX: QUS), or, for those investors comfortable with leverage the BetaShares Geared U.S. Equity Fund – Currency Hedged (hedge fund) (ASX: GGUS).

Please note: Gearing magnifies gains and losses and may not be a suitable strategy for all investors. Investors in geared strategies should be willing to accept higher levels of investment volatility and potentially large moves (both up and down) in the value of their investment. Geared investments involve significantly higher risk than non-geared investments. Investors should seek professional financial advice before investing, and monitor their investment actively. An investment in a geared fund should only be considered as a component of an investor’s overall portfolio. BetaShares Geared Funds do not track a published benchmark.

 

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