Big­ger earn­ings for stock funds have in­vestors re­lieved

The Denver Post - - BUSINESS - By Stan Choe

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 this month.

That’s be­cause the strong re­ports that are fore­cast would be more a jus­ti­fi­ca­tion for the big moves that stock prices al­ready have 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 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. 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 sec­ond­strongest earn­ings growth of the 11 sec­tors that make up the in­dex, at nearly 11 per­cent, ac­cord­ing to S&P Global Mar­ket In­tel­li­gence.

The strong­est growth this re­port­ing sea­son is ex­pected to come from the en- ergy 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 al­ready have 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.

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.

Richard Drew, The As­so­ci­ated Press

Spe­cial­ist Mario Pi­cone works at his post on the floor of the New York Stock Ex­change last week. The strong­est growth has come from the en­ergy sec­tor, which has been helped by the higher price of oil.

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