The importance of bigger earnings for stock funds
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 priceearnings 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:
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.
NEW YORK: Specialist Mario Picone works at his post on the floor of the New York Stock Exchange.