Trader Talk

The earnings story is getting more powerful

A trader works on the floor of the New York Stock Exchange (NYSE) in New York.
Brendan McDermid | Reuters

Despite weakness in commodities and commodity stocks, particularly oil, the broader stock market remains just below historic highs. There is an underlying bid to the markets.

There's a good reason for that underlying bid: the global economy is improving, and we are starting to see that in earnings. It's not just in the U.S. — even Europe is seeing an improved earnings picture.

Strategists and analysts have begun taking note. Keith Lerner, Chief Market Strategist at SunTrust Advisory Services, summed it up yesterday in a note to clients: "[W]e are seeing the most broad-based global earnings rebound since 2011."

He noted that International markets "are turning higher on better economic growth, policy support, and more competitive currencies." The percentage of countries that have seen their forward earnings estimates rise over the past three months is at its highest levels since 2009. Earnings growth is evident in both developed and emerging markets.

In the U.S., he notes, the percentage of companies exceeding sales estimates is at the highest level in almost six years. Cyclical sectors — those that benefit from an improving economy — are generally leading in terms of exceeding consensus earnings estimates.

The global rise in the stock market is not surprising: earnings are highly correlated with stock market returns. When the went through five quarters of earnings decline, what I termed the "earnings recession," from late 2014 to the summer of 2016, the stock market went nowhere.

But Lerner noted earnings started turning up in late summer of last year, and that's when stocks turned around (this was before the presidential election).

Moreover, the earnings trend is positive. The S&P 500 quarterly earnings for the first quarter, now at 14%, is the best in six years. Moreover, the percentate of companies beating estimates, at 76%, is well above the historical average of roughly 62%.

And it's not just buybacks that are boosting earnings: revenue growth is strong, too, up 7.2%

What about the second, third, and fourth quarter guidance? Lerner notes that about half of the S&P 500 companies have seen their earnings estimates raised by analysts, the highest level since 2015.

What could derail this earnings express? The recent weakness in oil is causing a modest (so far) downward revision in big oil estimates but is not derailing the broader market. Some kind of geopolitical shock, of course, could affect markets (North Korea is the current big threat). A major miscalculation by the Fed (raising rates too fast) might also slow the markets. And we know there is some premium in the markets for tax reform and infrastructure that might be taken out if they failed to pass something this year.

Of course, the traditional killer of earnings growth — and stock market rallies — is a recession. But Lerner and most other strategist see the chances of that happening as unlikely, at least in the intermediate term.

Recession risks are still low, Lerner said, "and we expect profits to continue to rise."