C.J. Lawrence Weekly – Improving Earnings Growth Forecasts Suggest the Bull May be Sharpening His Horns

Friday’s stock market roller coaster ride ended on a down note, but finished well off the lows of the day. Speculation about what former National Security Director, Michael Flynn, might say to the U.S. Special Prosecutor investigating his pre-inauguration activities, reversed the equity market’s previous risk-on posture, sent U.S. Treasury bond prices higher, the U.S. dollar lower, and gold higher. Then, around midday, reports circulated that the U.S. Senate had gathered the requisite votes to pass their version of tax reform legislation, and stocks quickly found a bottom and retraced their losses. The uncertainty surrounding the forthcoming Flynn testimony injects increased market risks and volatility in the coming weeks and months. But the economic and equity market backdrop remains positive, and continues to improve.

According to Tuesday’s release from the Organization for Economic Cooperation and Development (OECD) the global economy is now growing at its fastest pace since 2010, with the upturn becoming increasingly synchronized across countries. The OECD now forecasts 3.7% global economic growth in 2018. At home, the second estimate of third-quarter gross domestic product showed that the US economy grew at a 3.3% annualized rate, the strongest since Q3 2014. The New York Federal Reserve recently raised their 4Q17 GDP forecast to 3.8%, only a week after raising it to 3.2%. The globally synchronized economic expansion is intact, and that is good news for corporate profits. In the US., corporate tax reform may add additional fuel to what is already a crackling economic flame.

Forecasts now suggest that 2017 S&P 500 earnings per share (EPS) will be up over 10% from last year’s level. If that figure holds, it will be the first time that the Index has produced year-over-year double-digit earnings growth since 2011, as the economy climbed out of recession. According to estimates from FactSet, S&P 500 EPS are expected to grow 10.8% in 2018 and 10.0% in 2019. These figures do not include any benefit from corporate tax reform, as far as we can tell. If corporate tax rates are lowered to the 20%-22% range, those growth rates could potentially double. There have been only four periods, since 1960, when S&P 500 earnings grew at a double-digit clip for three consecutive years. With the exception of the 1972-1974 period, when the economy was headed into recession and investors were confounded with an inverted yield curve, stock returns averaged 14.7%, per year, during those periods. Many pundits are pointing to tax reform prospects and deregulation efforts as catalysts for the market’s 2017 rally. But accelerating GDP, at home and abroad, and corporate profit growth are the underpinnings on which durable bull markets are built. This one may be further from the top than consensus believes.

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