US Reporting Season

As of the 12th of October, twenty-eight S&P 500 companies that have reported Q3 earnings, 25 have beat their estimates (0 met, 3 missed). That’s the latest from US earnings authority Howard Silverblatt.

This “beat rate” of 89 percent is in excess of the average beat rate of around 70%. It also caps off three strong years of earnings growth for the US stock indices, with earnings from the S&P 500 rising approximately 45 percent in the last three years.

During that time, the value of the S&P 500 index itself has also rallied, with the index hitting several fresh all-time highs over the past 12 months. This rally led many to question the magnitude of the gains, and whether they could be sustained.

The post-GFC rally in US equities is now either the first or second largest rally in US share market history, depending on how you measure it. However, the rally has coincided with growth in economic fundamentals in the US, with GDP, unemployment, and corporate earnings reaching and holding very attractive levels.

As a result, S&P 500 P/Es have not been increasing despite the rise in the index. I.E. It can be argued that the recent price movements have been driven largely by increases in US company earnings, rather than simply unreserved buying.

In fact, the P/E ratio of the S&P 500 has actually declined since the end of 2017, with the decline extending with the sell-off of the past few weeks. The sell-off has taken the P/E ratio of the index back to levels not seen since 2015, and below the lows caused by the Brexit and 2016 election sell-offs.

Moving forward, there are certainly many headwinds that are causing some analysts to suggest US corporations are at peak earnings growth. They point to rising interest rates, US-China trade tensions, and the fact that recent drivers of the economy (such as the US corporate tax cut) were one-time in nature.

“The medium-term message, however, is that markets are witnessing peak EPS [earnings per share] growth,” according to John Norman, JP Morgan head of cross-asset strategy.

Such thinking has become prevalent amongst analysts seeking to explain the recent increase in volatility, and fall in US, and indeed global equities prices; as has the fact that the length of time since the previous equity market crash (the GFC) is quite significant compared to previous stock market cycles.

However, that is by no means an indication that this is the beginning of the next crash.

“These bouts of volatility can certainly be unnerving for investors, but we recommend focusing on the fundamentals,” according to LPL chief investment strategist John Lynch. “Corporate earnings growth is expected to remain strong in the third quarter amid a very healthy economic backdrop.”

US company earnings are also expected to continue rising at a rate of around 21 percent across the next 12-months, if that eventuates, it is unlikely that the current share price malaise is the beginning of the next stock market crash.