Got a 401(k)? You should be watching earnings season
Stocks are bullish, but companies may not be
The upcoming profit-reporting season could be a taxing one for anybody that owns stocks.
Indeed, 401(k) investors better hope CEOs are as upbeat about their companies’ future earnings prospects as Wall Street is when they talk about results for the final quarter of 2017.
The reason? Hopes are high. Perhaps too high.
The historic tax bill signed into law by President Trump on Dec. 22 that slashed the corporate tax rate from
35% to 21% has fueled a powerful stock market rally that has pushed shares to fresh all-time highs amid lofty expectations that corporations will make more money and the economy will grow faster. Those hopes helped drive up the Dow Jones industrial average
205.6 points, or 0.8%, to 25,574.73 on Thursday.
As a result, the increasingly expensive market could be vulnerable to disappointment if the forward-looking commentary from top executives doesn’t jibe with the bullish narrative.
The Dow, which gained 25.1% last year, is up nearly 856 points, or 3.5%, in the first eight trading days of 2018.
“This is definitely a make-or-break earnings season,” says Chris Rupkey, chief financial economist at MUFG, a New York bank. “The market is full of hope and sees little downside. So this is just the time that an unexpected disappointment can send share prices reeling.”
Here are a few earnings-related triggers that could either cause stocks and 401(k) balances to fall, flat line or keep rising:
High ‘beat’ rate needed
Analysts currently expect companies in the S&P 500 stock index to increase earnings at an 11.8% clip in the just-ended fourth quarter of 2017, according to earnings tracker Thomson Reuters.
Investors need a high “beat” rate — or lots of companies topping expectations — to keep the rally going, says Bill Hornbarger, chief investment officer at Moneta Group, an investment firm in Clayton, Mo.
“Disappointing earnings are probably reason for a pause and retrench- ment,” he says.
So far, 73% of the 22 S&P 500 companies that have reported results have exceeded forecasts. Key reports are set for release Friday from big banks J.P. Morgan Chase and Wells Fargo.
It’s all about ‘tomorrow’
Analysts, citing tax cut benefits, are already ratcheting up their profit growth forecasts for 2018. And the bulk of the upward revisions have come since Jan. 1. First-quarter profit growth is now estimated at 14.5%, up from 12.2%. Earnings growth for quarters two through four is now up to 13.8%, 15.4% and 13.8%, respectively.
Those double-digit percentage rates pose high hurdles for a stock market trading at 18.3 times expected 2018 earnings — roughly 25% more expensive than its long-term average.
“This earnings season is really about tomorrow and not yesterday,” says David Kotok, chief investment officer at Cumberland Advisors, a money management firm in Sarasota, Fla.
Investors will want CEOs in earnings press releases and conference calls to confirm that those upgraded growth rates are doable, warns MUFG’s Rupkey.
“It is the worry over future earnings that often causes traders to hit the panic button and sell, sell, sell if they feel the company’s outlook is not the positive one they were hoping for,” Rupkey says.
An upbeat Kotok doesn’t expect CEOs to deliver a negative message. “I expect strongly phrased positive conversation in conference calls,” he says.
“This is definitely a makeor-break earnings season.” Chris Rupkey Chief financial economist, MUFG
Give and take?
Some of the earnings benefits companies derive from lower taxes could be partially offset by them sharing their expected windfall with workers via cash bonuses and pay hikes, as well as boosting their capital expenditure budgets, says Michael Farr, president of Farr Miller & Washington, an investment firm in Washington, D.C.
“There is some pressure on management teams to ‘share’ some of the tax windfall with employees,” Farr says, noting that Walmart on Thursday was the latest U.S. company to announce one-time bonuses and minimum-wage hikes for its workers. “These expense increases could be a drag, albeit somewhat minor, on earnings (this) year.”
More investment spending, Farr adds, “will likely to eat into earnings” as well.
Jonathan Golub, chief U.S. equity strategist at Credit Suisse in New York, says the new tax law is a game-changer.
“This will be the last earnings season for an apples-to-apples earnings comparison given-tax related changes,” he noted in a report.