Corporate America Made Some Money in Q4

With recent market volatility—and speculation about whether it is behind us—dominating headlines of late, we want to take a moment to highlight a key bull market driver: rising profits. US companies hauled in a lot of these in Q4, which we believe signals healthy global demand persisted as 2017 closed. While that is all in the past, forward-looking indicators suggest continued economic growth should power profits higher—to us, all evidence of this bull market’s continued strength.

With 90% of S&P 500 firms reporting as of February 23, FactSet estimates S&P 500 earnings grew 14.8% y/y in Q4, while revenues grew 8.3%.^[i] 74% of reporting companies have beaten earnings estimates and 78% have beaten revenue estimates. The latter is the highest since FactSet began tracking this in 2008—not a long history by any stretch, but a notable factoid.

Growth is broad-based, too: All 11 sectors appear on track for Q4 sales and profit growth—a post-2011 first. Energy leads the pack with 106% y/y earnings growth^[ii] thanks to favorable year-over-year comparisons—in Q4 2016, the sector was still recovering from the squeeze of low oil prices—but earnings growth ex. Energy is still 12.8% y/y.^[iii] The insurance subsector (part of Financials) was another bright spot: Earnings rebounded from Q3’s hurricane-induced -63% y/y decline to rise 32% in Q4.^[iv]

While double-digit earnings growth is notable, we think the striking revenue growth is the kicker. First, it shows burgeoning global demand is driving profits as most developed economies grow together. While “synchronized” growth isn’t necessary for a bull market or expansion to persist, it is still a nice tailwind. Second, despite lots of talk about corporate tax cuts’ potential effect on 2018 earnings, strong Q4 revenue totals predate it—showing firms just aren’t relying on Uncle Sam to save their bottom lines.

Forward-looking indicators suggest US economic expansion should keep powering up corporate earnings. New orders gauges indicate further expansion—today’s orders are tomorrow’s production. ISM’s January manufacturing new orders measure fell from 67.4 to 65.4, but this is still one of the highest readings in a decade and well over 50, the line between growth and contraction. The new orders component of ISM’s non-manufacturing gauge—which represents about 70% of the US economy—jumped to 62.7 in January from 54.5 in December. Whether or not it remains that high, new business has been growing nicely for a long while, which bodes well for future output. Lastly, the US Leading Economic Index (LEI) rose again in January (1.0% m/m versus 0.6% expected) and has accelerated in the last three months. The positive yield curve spread remains a big contributor. In US LEI’s nearly 60-year published history, no US recession began while the gauge was high and rising. Corporate earnings don’t necessarily move one-to-one with any of these factors, but a broadly growing economy should benefit them.

A look ahead suggests more reason for cheer. Analysts currently expect US Q1 earnings growth to hit 17.3% y/y and revenue growth to slow slightly to 7.5%.^[v] If these estimates prove accurate, both figures would be quite good by historical standards. Interestingly, stocks’ early-February plunge didn’t ding analysts’ earnings expectations, which have steadily risen since September. During past corrections in this bull market, analysts have been fast to ratchet down expectations, presuming the dip indicated trouble ahead. But now, analysts seem to be more rationally assessing fundamentals. While earnings estimates are just one snapshot of sentiment, this shows optimism toward stocks is growing.

For those worried current earnings projections are getting too rosy, though, consider: Actual earnings growth managed to outpace estimates in recent quarters even as expectations ticked up. Maybe they undershoot now, maybe not. But with leading indicators hinting at more growth to come, the risk of expectations shooting impossibly high seems low. Solid economic fundamentals coupled with improving sentiment are typical of a maturing bull market—a big reason we doubt this one is running out of steam.

[i] FactSet, as of 2/23/2018. Blended Q4 2017 S&P 500 earnings and revenue growth.

[ii] Ibid. Blended Q4 2017 earnings growth for the S&P 500 Energy sector.

[iii] Ibid. Blended Q4 2017 earnings growth excluding the S&P 500 Energy sector.

[iv] Ibid. Blended Q4 2017 earnings growth for the S&P 500 Insurance industry group.

[v] Ibid. Expected Q1 S&P 500 earnings and revenue growth.