Over half of all companies that make up the broad-based S&P 500 Index, which, as the name implies, is made up of 500 companies, have reported through the end of April. So far profits are expected to rise an astounding 25% versus a year ago, according to Thomson Reuters I/B/E/S.
Just for perspective, anything above 10%, a double-digit increase, would be viewed as solid.
Here’s another yardstick. Nearly 80% of companies that have reported are besting analyst estimates, and they are surprising to the upside by a wider-than-normal margin (Thomson Reuters).
Let’s add some icing to the cake. Analysts had already been raising forecasts in response to the just-passed cut in the corporate tax rate–from 35%-21%. So, it’s not as if firms have been clearing a low hurdle. In fact, expectations were high going into the Q1 earnings season.
Companies are performing extremely well and strong growth is expected throughout 2018. Sure, the cut in corporate taxes is adding a shine to profits, but so are the fundamentals–economic growth at home and abroad.
But, you may ask, why aren’t shares soaring to new highs? Great question.
We believe there are a few factors in play.
First, forecasts that were issued for Q1 were quite strong, according to FactSet. It’s a sign of confidence, but it also raises the bar. In other words, all the good news gets priced into stocks and even great news fails to move the needle.
A second factor that appears to be playing a role is the impressive surge in profits. It sounds counter intuitive but let me explain.
Investors are interested in current numbers but more importantly, they also look to the future. Profits are soaring and are expected to remain strong this year. However, today’s numbers aren’t unsustainable.
It is too soon to say profit growth peaked in Q1, but it’s very likely we’ll see a slowdown to a more sustainable level next year, assuming the economy doesn’t slip into a recession.
Rising interest rates have also dulled interest in stocks. The Federal Reserve is expected to raise interest rates at least three times this year, and the yield on the 10-year Treasury bond has been ticking higher.
In our view, faster economic growth that prompts a more aggressive Fed wouldn’t be viewed as much of a headwind for stocks, which could force the Fed’s hand.
But all is not gloomy. While stocks may not be cheap, markets are no longer frothy as they were heading into 2018. Additionally, odds of a bear-market-inducing recession this year remain low.
Strong profit growth is not fueling new highs but, coupled with a growing economy, it has provided underlying support for the broader stock market.
Last year, we were treated to an out-sized gain. Good news fueled the advance, and any bad news didn’t stick—a Teflon market.
Last year, 2017, left some investors with a false sense of security. Throw in very low volatility and it’s easy to forget that pullbacks are the norm.
Shares are now in a consolidation period. Since peaking in late January, the S&P 500 Index is down a modest 7.8% (MarketWatch data), well within normal gyrations we’d expect in a year.
In the context of a growing economy, today’s pause skims the excess euphoria away from investor psychology and can reestablish a foundation for shares.
The continuation of last year’s melt up would have been fun, but extended melt ups rarely end well, and they end when you least expect it.
Table 1: Key Index Returns
|MTD %||YTD %||3-year* %|
|Dow Jones Industrial Average||0.3||-2.2||10.6|
|S&P 500 Index||0.3||-1.0||8.3|
|Russell 2000 Index||0.8||0.4||8.1|
|MSCI World ex-USA**||1.9||-0.8||1.9|
|MSCI Emerging Markets**||-0.6||0.5||3.6|
|Bloomberg Barclays US |
Aggregate Bond Trust
Source: The Wall Street Journal, MSCI.com, MarketWatch, Morningstar
MTD returns: Mar 29, 2018—Apr 30, 2018
YTD returns: Dec 29, 2017— Apr 30, 2018
MSCI returns run through Apr 30, 2018
**in US dollars
We hope you've found this monthly update to be very helpful and educational. If you have any questions and would like to discuss your portfolio or other important financial matters, please give us a call at (330) 836-7000 or schedule an appointment with us here.
Many happy returns on life,
Jonathan Torrens CFP®
President and Chief Investment Officer
TCM Wealth Advisors