Bull Mar­ket in US Stocks is Jus­ti­fied by Earn­ings

Prof­its and rev­enues beat ex­pec­ta­tion, and the US econ­omy is per­form­ing bet­ter than fore­cast

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We’re still in the heart of earn­ings sea­son, with more than 40% of the S&P 500 com­pa­nies ac­counted for.

A few ob­ser­va­tions are al­ready note­wor­thy. Most im­por­tantly, third-quar­ter cor­po­rate prof­its and rev­enues rose faster than ex­pected and ad­di­tional in­for­ma­tion is un­likely to change this trend. Also, the econ­omy more broadly is per­form­ing bet­ter than fore­cast. Gross do­mes­tic prod­uct in­creased 3% in the quar­ter, a very solid num­ber con­sid­er­ing that hur­ri­canes dis­rupted growth dur­ing the pe­riod. The mo­men­tum be­hind the data sug­gests a pos­i­tive neart­erm out­look for US com­pa­nies and the econ­omy. Al­though stock prices have done quite well re­cently, there’s ev­ery rea­son to ex­pect more gains in the months ahead, as well as more weak­ness in the bond mar­ket.

By one count, earn­ings-per-share beats are as much as four times greater than EPS misses, a no­tably large dif­fer­ence. Also, sales have also been run­ning at least three times faster than misses in rev­enues. These are very solid gains. More­over, three of the largest com­pa­nies — Ama­zon, Al­pha­bet and Exxon Mo­bil — hand­ily topped es­ti­mates of prof­its and sales. Nonethe­less, these strong per­for­mances make sense when GDP has out­per­formed ex­pec­ta­tions.

The hur­ri­canes that hit Texas and Florida were thought to have re­duced growth by some­where be­tween 0.5% and 1% at an an­nual rate for the third quar­ter. If that es­ti­mate is cor­rect, it sug­gests the econ­omy was mo­tor­ing along quite nicely be­fore the storms. In­deed, the third-quar­ter gain fol- lowed a 3.1% ex­pan­sion in the se­cond quar­ter. And any re­duc­tion in growth caused by the storms will boost fourth-quar­ter ac­tiv­ity, as the dam­age is re­paired and the lost items are re­placed.

This is most ob­vi­ously the case for au­tos. Hur­ri­canes Irma and Har­vey are thought to have de­stroyed more than 500,000 ve­hi­cles. In­deed, auto sales have in­creased from a 16.5 mil­lion an­nual sell­ing rate in Au­gust to an 18.9 mil­lion rate in Septem­ber, a surge that re­places about one-third of the cars lost so far. So, sales in Oc­to­ber should also be fairly ro­bust.

What does all this mean for mar­kets? The very ro­bust stock per­for­mance of re­cent weeks, along with the weak­ness in bonds, is the cor­rect re­sponse for mar­kets. We re­main pos­i­tive (though not eu­phoric) on stocks and ex­pect a pound­ing for bond prices.

Look­ing ahead, stronger growth prom­ises to main­tain the fairly rapid pace of de­cline in the un­em­ploy­ment rate, ren­der­ing labour scarcer and re­in­forc­ing up­ward pres­sure on worker costs. This will present some pol­icy is­sues for the next Fed chair­man. More­over, noth­ing on the hori­zon threat­ens to un­der­mine these trends. All of this is pos­i­tive for pro­jec­tions of cor­po­rate prof­its and dam­ag­ing to bond prices. Passage of the first bud­get bill that could po­ten­tially lead to tax re­form, lower rates for house­holds and busi­ness, and a larger bud­get deficit only strength­ens these forces al­ready in place. Even so, the mar­ket will not be­lieve it or price it into mar­kets un­til the fis­cal pro­gramme is much closer to fi­nal ap­proval. Thus, the pos­i­tive per­for­mance of stocks and the neg­a­tive per­for­mance of bonds does not yet re­flect the pos­si­bil­ity of tax re­form, since that re­mains only a pos­si­bil­ity at this stage. Mar­kets are re­flect­ing what they see oc­cur­ring, which is solid GDP growth and prof­its. — Bloomberg

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