Weekly commentary providing analysis with an outlook for the equity market.
Scott Wren, Senior Global Equity Strategist
Forward Outlooks Matter, Not Fourth-Quarter Results
- As we enter into the bulk of the fourth quarter earnings season, actual results will be far less important to the market than comments related to the effect of the new tax code on earnings and capital expenditures.
- The question is will companies be able to accurately make statements on these effects and issue guidance.
The fourth-quarter earnings reporting season is on the brink of launching into full-swing mode. Coming into this earnings season, we have been looking for growth in the 10% to 12% range. That rate of year-over-year change might normally sound pretty exciting, but probably not this time around. Our Equity Strategy group and the consensus all know that the probability of a disappointing earnings season is low. Economic growth has picked up here at home and abroad, and domestic consumer and corporate optimism is high. In fact, we might see the third consecutive quarter of 3% or more economic growth next Friday when the government reports gross domestic product (GDP) for the final three months of 2017. So why would a good earnings season not excite investors? After all, the S&P 500 seems to set a new record high just about every week. And we haven’t had even a 3% correction in that index in more than a year.
So somebody is obviously really excited about something. But this strategist can almost guarantee you it isn’t the potential for good earnings results in the fourth quarter of last year. During this reporting season, analysts and investors are going to be asking lots of questions and paying close attention to what companies have to say in terms of how the new tax code will affect their profitability and the behavior of their customers. That’s because the new tax code represents the start of a whole new ball game, one that could very well extend this long expansion by a couple more years.
Each and every earnings reporting season attracts a ton of attention from the media. But this recovery, at least so far, has featured mostly modest economic growth and low inflation. Given that reality, actual results for most companies usually have not differed much from company guidance. It has been relatively easy for analysts to be confident about their companies’ projections. But this year could be different. Individual company analysts will likely have a tougher time confirming the guidance their companies are giving out. They are going to need to feel comfortable with how projected economic growth, consumer spending, and corporate capital spending will affect their companies. The problem is, in many if not most cases, neither the analyst nor the companies themselves will have high degree of confidence as to how things will actually pan out. Remember that company guidance, historically, nearly always leans toward the conservative side—especially after game-changing events like this year’s big corporate tax cuts. That is why, quarter after quarter, it is common for 65% to 70% of companies to beat the average “Street” estimate.
What we are listening for as companies report fourth-quarter earnings results is what companies plan to do with their tax windfall. Will they be ramping up capital expenditures immediately, or will they wait to see sales growth? Have they had enough time to contact their customers to get a feel for how these end users will be affected? And what about stock buybacks? In the coming weeks, as earnings reporting season heats up, pay attention to the forward outlooks, not fourth-quarter results. That’s what really matters.
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