Earnings Recovery In Focus

1/9/2017


Stocks began 2017 on the front foot, with solid economic data bolstering expectations for year-ahead earnings. U.S. stocks are pricey. But, with the Dow Theory in the bullish camp and several high-quality growers still available at reasonable valuations, a nearly fully invested posture remains appropriate.

Earnings expectations

While the election results receive much of the credit for the market's strength, the improving outlook for corporate earnings also deserves notice. After stalling for most of 2015 and the first half of 2016, consensus estimates for year-ahead earnings have jumped to all-time highs.

Consensus estimates project 3.2% year-to-year profit growth for the S&P 500 Index for the December quarter, which would mark the first back-to-back increases since the beginning of 2015, according to FactSet. A smaller-than-typical number of companies have warned on December-quarter results, and history suggests actual earnings growth will exceed the consensus by at least 2% or 3%.

Excluding the hard-hit energy sector, earnings for full-year 2016 are projected to be up 3.4%, says FactSet. For 2017, the consensus projects 11.5% earnings growth on 5.9% sales growth for the S&P 500 Index. While history suggests those numbers are optimistic, even high-single-digit earnings growth might be enough for a transition to an earnings-driven market.

Since 2014, expectations for long-term earnings growth have eroded steadily. For companies in the broad S&P 1500 Index, the average expected long-term growth rate for per-share earnings is 10.2%, the lowest number since the index's 1994 inception.

As profit expectations have dropped, shares of companies with superior earnings momentum have underperformed. So have shares of companies with superior growth prospects. As a result, shares of such companies now trade at a smaller-than-normal premium relative to other stocks.

If investors gain some confidence that the earnings outlook has stopped deteriorating, their willingness to bet on superior growers is likely to improve. In other words, the December-quarter earnings season is likely to be crucial.

Conclusion

A constructive stance toward stocks seems appropriate. Our Focus List and Buy List have 100% in stocks, while our Long-Term Buy List has 94%. For new buying, we like such reasonably valued growers as CBS ($66; CBS), F5 Networks ($145; FFIV), and Lear ($136; LEA).


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