2Q18 US earnings update: Tug of warContributors Global Markets Insights Strategy Team, David Lebovitz, Tyler Voigt
- 2018 has seen the stock market struggle to find direction, as political risks and robust earnings growth have offset one another, complicating the investment landscape.
- 2Q18 was another solid quarter for corporate profits, with financials, technology, and energy companies continuing to post impressive numbers.
- Healthy earnings, coupled with the repatriation of foreign profits, have left companies flush with cash. How they use that cash, however, is still in question.
- The yield curve is flattening, but not inverted. Although earnings growth will slow next year, there is still room for equity markets to grind higher before the cycle comes to an end.
- Certain sectors and styles stand to benefit from tax reform more than others, suggesting an active approach to investing is warranted in the current environment.
Politics vs. fundamentals
The stock market is caught in a tug of war between politics and fundamentals. On the one hand, escalating trade tensions and the potential for additional tariffs suggest caution may be warranted; on the other, robust economic and profit growth support risk assets continuing to climb higher. So far the fundamental forces seem to be winning-as evidenced by the S&P 500’s positive year-to-date return-but the recent softening in confidence indicators, albeit from elevated levels, will be worth monitoring.
Against this turbulent policy backdrop, the 2Q18 earnings season is continuing the streak of healthy profit growth that began nearly two years ago. With approximately 62.6% of companies reporting, 84% are beating earnings estimates and 60% are beating sales estimates. Looking at a combination of reported earnings and analyst estimates, we forecast 2Q18 S&P 500 profits grew by 28% from a year prior.
As shown in the Exhibit 1, many of the themes that dominated earnings announcements in the first quarter have continued-a significant benefit to profits from tax reform, higher oil prices supporting energy sector earnings, and a weaker U.S. dollar benefitting those companies with healthy revenue generation outside the United States. In other words, the stars aligned once again for earnings in the second quarter. We estimate that tax reform is responsible for about 7%-pts. of the earnings growth seen in 2Q, while a weaker U.S. dollar and higher oil prices have contributed 3%-pts. and 1%-pts. respectively. Furthermore, profit margins look to have hit an alltime high of 11.8%, as low rates, still-weak wage growth, and lower taxes all provide a boost to profits.
EXHIBIT 1: 2Q18 DRIVERS OF EARNINGS GROWTH
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