US listed companies, which report earnings on a quarterly basis, are winding down the 2Q18 US earnings season with over 90% of these companies having reported results by the end of last week. In terms of S&P 500 companies, 463 have reported as at the close of business on 16 August and, according to Thomson Reuters I/B/E/S, 79.3% of these companies have exceeded analyst estimates. Meanwhile, according to Bloomberg data, S&P 500 companies have delivered impressive YoY earnings growth of c. 25%-plus and YoY sales growth of around 10% in the second quarter. The earnings growth is c. 5% ahead of expectations. Both earnings and sales growth have accelerated for the past five quarters, outlining a positive outlook for the US economy and US businesses.
In terms of companies, even Facebook, which had almost $120bn wiped from its market cap as the share price plummeted c. 19% the day following its results release, actually delivered great earnings growth (+30% YoY or 5% ahead of expectations). The dramatic share price drop following its 2Q18 results, was because the social media giant shocked the market by guiding to operating margins that would gradually shrink towards 30% from the current level (44%). CFO David Wehner attributed this to three factors: 1) currency headwinds, 2) promoting Stories instead of a Newsfeed in Facebook, and 3) providing users with more privacy options. Wehner also said that expenses would grow faster than revenues, causing operating margins to fall. Companies which reported standout results include Apple (which saw its market cap top $1trn following the results), Amazon, Walmart (which was boosted by 40% YoY US e-commerce sales growth), Home Depot and Morgan Stanley. Even more importantly, in a lot of cases the guidance for future quarters was also strong.
Most corporates are still seeing their earnings boosted by lower tax rates and a US dollar, which is slightly weaker than for the same period last year. US President Donald Trump’s administration passed the Tax Cuts and Jobs Act in December 2017 and this tax reform has been responsible for the biggest proportion of earnings growth for the first two quarters of 2018. It is expected to continue to be a tailwind for companies in 3Q18 and 4Q18. After this it will be in the base and from next year the impact of tax cuts on earnings growth will disappear.
The other factor that’s had a meaningful impact on US corporate earnings growth is the relatively weaker dollar. In 1H18, the broad trade-weighted US dollar was c. 4.3% weaker than in 1H17 – another definite tailwind for the US dollar equivalent of global corporates’ non-US earnings in the quarter under review. However, while at current levels, the US dollar is roughly 4% stronger than its average level during 2H17, if it settles at around these levels it will switch from a 4% tailwind in 1H18 to a 4% headwind in 2H18. The impact on S&P earnings is nevertheless difficult to predict, since different companies have exposure to divergent currencies and some companies hedge their currency exposure. On balance, however, we believe that it could very well be a drag on 2H earnings.
So, are we seeing peak earnings, and could the US market go down from these levels due to US trade-war threats against China and other countries? Peak earnings aren’t necessarily a negative for markets going forward, provided that these lower earnings are factored into market expectations and analyst valuations and forecasts. Expectations for 1Q19 and 2Q19 earnings are already reflecting the loss of the tax impact from the base and expectations are for c. 8% YoY earnings growth in both quarters. Provided that these lowered growth expectations are met next year, there should be no reason why markets can’t continue to deliver returns in-line with earnings growth. However, for now, the trade-war rhetoric seems to be a tool which Trump is using to negotiate better access to Chinese markets for US companies and improved regard for US intellectual property. To the extent that negotiations drag on, it could weigh on confidence and global trade which could, in turn, drag economic growth lower and likely filter through to corporate earnings. That said, for now, it seems likely to only affect a limited number of companies – those directly impacted by the list of goods subjected to tariffs.
This (2Q18) earnings season has once again reinforced the view of many market commentators that the US economy and companies will continue to grow. At present, it seems that the current (post-2008) bull market is continuing at apace and it is likely that share prices will also continue to rise, as earnings growth remains solid.
