The importance of bigger earnings for stock funds
By STAN CHOE
Jul. 20, 2017
NEW YORK (AP) — This earnings season is off to a good start, and the encouraging run is expected to keep going.
Instead of excitement, though, the reaction so far from Wall Street has been more like quiet relief, and funds that track the broad stock market have only edged higher since earnings reports began arriving in earnest last week. That's because the strong reports that are forecast would be more a justification for the big moves that stock prices have already made rather than reason for further gains.
Stock prices have risen more quickly than earnings in recent years, and the two tend to track with each other over the long term. Stocks even rose when profits were shrinking from mid-2015 into 2016, which has the market at more expensive levels relative to corporate profits.
Stock prices for companies in the Standard & Poor's 500 index are trading at close to 21 times their earnings per share over the last 12 months, for example. That's well above their average price-earnings ratio of 15.5 over the last 10 years, a period that includes both the Great Recession and the long run-up for stocks following it.
Of course, interest rates are still low, and investors are willing to pay a higher price for each dollar of earnings in stocks when bonds are offering small yields. But rates are expected to continue climbing modestly, as the Federal Reserve raises short-term interest rates and begins paring back its massive trove of bond investments.
So, depending on how high interest rates climb and other factors, corporate earnings may need to keep rising just to keep stock prices where they are today. This reporting season, analysts are expecting S&P 500 companies to report a roughly 6 percent rise in earnings per share from a year earlier. That would be less than half the growth rate of the first three months of the year, but the slowdown is understandable given that the first quarter's growth rate was the fastest since 2011.
Among the trends to watch for as companies report how they did from April through June:
— GLOBALISTS GLITTER
Coming into this year, many expected President Donald Trump's "America First" policies to mean companies that do most of their business at home would be the biggest winners.
But the companies that get most of their sales from abroad may end up this earning season's stars, now that Europe and developing economies around the world are showing more life after years of disappointment.
Those economic upturns, coupled with a weakening dollar, spell stronger results for companies that sell a lot to customers in Asia, Europe and elsewhere. The euro has climbed about 10 percent against the dollar this year, for example, which means that each euro of sales at the Apple store in Amsterdam is worth more dollars than before.
Like Apple, the technology sector broadly gets most of its revenue from outside the United States, and analysts expect tech stocks to report the second-strongest earnings growth of the 11 sectors that make up the index, at nearly 11 percent, according to S&P Global Market Intelligence.
— OIL IS A WILD CARD
The strongest growth this reporting season is expected to come from the energy sector, where analysts say profits more than quadrupled from a year earlier.
Energy is the only area of the market that's more international than technology in terms of where it gets its revenue, but the biggest factor is the higher price of oil. After plunging below $30 per barrel early last year, crude has remained between $45 and $55 for much of this year.
It's easier to make outlandish percentage gains when coming off a small base, and energy companies' profits were decimated by oil's fall from more than $100 per barrel in 2014.
But crude's price still isn't stable. During June, it dropped as low as $42.05 on expectations that the world still has more oil than it needs. Analysts have already pulled down their earnings expectations as a result, but did they do so by enough? And if oil's price remains volatile, it could have a big impact on energy companies' earnings for the second half of the year.
— OUTLOOK IS KEY
For stocks to rise any more from their already lofty levels, companies will need to keep pumping out further earnings gains, even after this reporting season closes.
For the most part, that's what analysts expect to happen. The U.S. economy continues to muddle along with modest growth, while other economies are accelerating. Companies, meanwhile, have slashed their costs and are able to hold onto more of each dollar in revenue as profit.
Corporate CEOs will offer their own clues for where they see profits heading for the rest of the year when they release their second-quarter results. Many are forecasting further gains, though they have ratcheted back their expectations for how much of a boost they may get from a potential tax cut or other changes from Washington.