UBS: Stocks to hit new highs as earnings recession ends

Published Fri, Oct 14 20165:00 AM EDT

UBS predicts the stock market could stage a year-end rally as the so-called earnings recession ends. "S & P 500 earnings have largely stagnated over the past few quarters, but the outlook is set to improve," Jeremy Zirin, head CIO investment strategist, wrote in a research note this week as third-quarter earnings season got underway. Zirin believes the primary culprits for a slowdown in earnings — energy and a strong dollar — are dissipating, while U.S. economic growth in the second half of 2016 and into 2017 could climb to 2 percent from 1.1 percent in the first half of 2016. "A moderate economic growth pickup, fading energy and currency headwinds, and an improving tech sector outlook should help drive a US profit recovery over the next several quarters," he said. Below are the chief reasons the investment bank is telling clients to remain "overweight" U.S. equities: 1. Earnings are not as bad as they seem When energy is taken out of the mix, the trend in earnings has not been as negative as it appears, said Zirin. The strategist explains that if energy, the biggest drag on earnings, was excluded from the calculations as shown in the chart below, earnings would have been negative in only one quarter, and not four. "There has not been a broad-based decline across market sectors, but rather a collapse (–80% peak to trough) in energy profits, a more moderate profit decline for companies with a high percentage of revenues derived overseas, and generally fairly healthy EPS growth for the remainder of index," he wrote. 2. Energy and the strong dollar are no longer a threat Zirin thinks the rally in oil, which is up 36 percent this year, marks a turning point for the sector. "Energy earnings will still be down big — likely off by 60–70% or so – in 3Q, but year-over-year comparisons become much easier starting in 4Q and sector earnings growth should be close to flat in 4Q," he predicts. Similarly, he believes the U.S. dollar will remain range bound, as other world currencies such as the euro stabilize. "The negative impact to S & P 500 earnings from the strong dollar should vanish by year-end. In fact, over the past month, two U.S. companies with significant overseas exposure — PepsiCo and Phillip Morris International — raised their full-year 2016 earnings guidance partly due to a smaller-than expected currency impact on profits," he wrote. 3. Earnings revisions are heading up "The percentage of companies with rising forward-looking earnings estimates has improved substantially, and has been slightly positive (more estimates are rising than falling) over the past three months," said Zirin. He points to technology and health care as the two groups with the highest positive earnings revisions. 4. Big earnings from tech Technology, the largest sector in the S & P 500 with a 21 percent weighting, will show robust growth, lifting up overall estimates. "Looking ahead, tech earnings appear set to re-accelerate. Similar to other sectors, the weaker dollar will help tech companies with a high percentage of sales outside of the U.S. While the S & P 500 derives about one-third of its sales overseas, sales outside the U.S. constitute well over half of tech sector revenues," said Zirin.

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UBS predicts the stock market could stage a year-end rally as the so-called earnings recession ends.

"S&P 500 earnings have largely stagnated over the past few quarters, but the outlook is set to improve," Jeremy Zirin, head CIO investment strategist, wrote in a research note this week as third-quarter earnings season got underway.

Zirin believes the primary culprits for a slowdown in earnings — energy and a strong dollar — are dissipating, while U.S. economic growth in the second half of 2016 and into 2017 could climb to 2 percent from 1.1 percent in the first half of 2016.

"A moderate economic growth pickup, fading energy and currency headwinds, and an improving tech sector outlook should help drive a US profit recovery over the next several quarters," he said.

Below are the chief reasons the investment bank is telling clients to remain "overweight" U.S. equities: