Market Pulse: Earnings explain everything
August 1, 2018
In the last few months talk of a trade war with China and the European Union dominated the news along with North Korea and steel/aluminum and other tariffs.
Those triggered market moves both up and down. Then there was a political crisis in Italy. A few years ago investors were rattled by debt crises in Greece, Portugal, Iceland, Spain and Cyprus, then by the Brexit vote in the U.K. There is always something.
Crises, real or perceived, have come and gone and there will surely be more ahead. Still, the stock market has advanced 5 percent. How can that be? After all, the media reporting is far more negative than positive, Washington is as dysfunctional as ever and interest rates will rise further.
The answer is in one word — earnings. Yes, current and more important expected earnings, both of which are working their way higher and justifying valuations that may seem high but only if one ignores the growth outlook.
In their second-quarter reports companies are optimistic about revenue and earnings growth in the U.S. though less so about their European operations. Until the tariff situation is clarified, expect CEOs in their public comments to be cautiously optimistic and say little other than that they’re pleased that the economy is expanding at a fast clip and profits are growing.
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In their second-quarter reports companies are optimistic about revenue and earnings growth in the U.S. though less so about their European operations. Until the tariff situation is clarified, expect CEOs in their public comments to be cautiously optimistic and say little other than that they're pleased that the economy is expanding at a fast clip and profits are growing.
Second-quarter profits are rising at about 20 percent, down from the first-quarter's pace of 27 percent, but still heady. But 20 percent growth is unsustainable — even 10-12 percent would be terrific.
With such profit growth this year the market's price-earnings ratio has fallen to a historically average level (15-17). But these are not historically average times. They are much better than that. Why? Low tax rates, fewer rules and regulations, and a pro-business, pro-investor administration.
Some may feel that the earnings growth rate is peaking. Yes, over the long term earnings cannot grow at 18 percent or even come close. At 10 percent, perhaps. But earnings growth of 10 percent, the forecast for next year and 2020, is certainly enough to push stocks higher from today's average valuation levels.
While the headlines are mostly about tariffs, there is a lot more going on. Economic data are for the most part solid and consumer and business confidence remains high.
The economy is in very good shape and growing at a fast rate. That translates to strong earnings growth in the second half and into next year. That is why stocks have moved higher. And will continue to do so.
David Vomund is an Incline Village-based fee-only money manager. Information is found at http://www.VomundInvestments.com or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.