Consecutive Double Digit Earnings Growth is Bullish, Terry Gardner CJL Market Commentary 050224

C.J. Lawrence Market Update: May 2nd, 2024 Good afternoon, everyone. It’s Terry Gardner from C.J. Lawrence on Thursday, May 2nd. Happy May everyone! I am coming to you from Midtown Manhattan. Today, I have a couple of things I wanted to discuss:

1. Previous Earnings Cycles: I want to share the work we did on the previous earnings cycle and discuss why I think it’s supportive of higher stock prices.
2. Current Earning Season: We will take a look at the current earnings-season reporting for the first quarter of 2024, and see how results are coming in, and in what sectors growth is being generated.
3. Remainder of 2024: We’ll explore the balance of the year to see where earnings are expected to come in much higher, double-digit improvement from current levels, on a sector-by-sector basis.

Interest Rates & the Market Before I really begin discussing earnings, yesterday was Fed Day. The Federal Reserve Board left interest rates unchanged. I think that was largely expected. In terms of the messaging, perhaps one thing that the market grabbed onto was a question that Chairman Powell was asked regarding the potential for interest rate hikes. He suggested that the potential for further tightening was unlikely. That seems to have given the market a little bit of comfort. Here at C.J. Lawrence, we’ve always viewed earnings and interest rates as key factors in determining valuations and stock prices. The interest rate environment seems to be somewhat steady for the time being, with the path likely to be lower rates over time. The timeline for lower rates is a little bit unclear, but I think it’s fair to assume, especially after yesterday’s discussion, that the next movement in rates will be lower. Past Earnings Cycles and Market Performance Let’s get to the earnings discussion because we did a little bit of work on past cycles. What is interesting to us is that starting this year, 2024, we are expected to have three consecutive years of double-digit earnings improvement. There have only been five times since 1950 when that has happened for three consecutive years. In terms of what those numbers are that we’re looking at for the current cycle, expectations are for earnings to grow 11.2% this year, 13.9% next year in 2025, and another 11% in 2026. Again, we’ve only had that happen five times in the last 70 or so years. Two of those periods came on the back of a recession, so earnings dipped dramatically and then rose in three sequential years after the recession. We are going to strip those two periods out for the purpose of our analysis. One other period when that happened was 1972-1974, where you had wage and price controls, you had stagflation, and you had the end of the gold standard. A very difficult comparison. We’re going to move that period out to the side for a second as well, which leaves two other periods of three consecutive years of double-digit earnings growth. They would be in 1963-1965, and then again in 1993-1995. During those two periods, the 10-year treasury bond yield averaged 5.4%, almost a percent higher than where it is today. Inflation, during those two periods, average as measured by headline CPI, was 2.2%, about a percent lower than our current rate. Interest rates were higher by a percent, inflation was lower by a percent, so it’s a fair comparison. The average return during those two periods was 17.1% and 16.2%. I’m throwing a lot of numbers out there, but the message is: When you get three years of double-digit improvement in earnings growth, the results in the market tend to be pretty good, and that’s supportive for higher stock prices. We thought this was important information to share. We’ll continue to watch earnings as they come in and look to see that those double-digit expectations are maintained. Right now, they look fairly solid. Q1 Earnings Update In terms of earnings and how they’re coming in for the first quarter, which is point number two, they’re being reported now — we’re about 75% of the way done with S&P 500 companies reporting. The results have been quite good with 79% reporting positive surprises. That’s about a 20-year average, certainly in the ballpark. Where is the earnings growth coming from? No, huge surprises here. Communication services, which are your Alphabet, your Meta, and your Netflix have generated 40% earnings growth in the communication services sector on a year-over-year basis, quite impressive. Consumer discretionary was 35%, technology 25%.  Impressive earnings growth from the big sectors. What’s dragging it down? Staples was 4.8%. Financials are 5%. Industrial is 8%. The real drag has been energy down 26%, materials down 21%, and surprisingly, healthcare, so far, down 29%. You can see where the growth is coming in and where it’s not. Sector Growth That leads us to our final point about expectations for the year because it’s spread as the quarter is showing you, and so too is the earnings growth spread across sectors. It’s the haves and the have-nots. Interestingly, they’re the same sectors that did well in the quarter, expected to do well for the year. Communication services, which account for about 10% of the S&P 500 index weight, are expected to drive 22% or deliver 22% earnings growth. Technology, which is almost a third of the weight of the S&P 500 at 29%, has 17.2% earnings growth this year. Consumer discretionary, which includes Amazon and Home Depot — 12.6%. You can see the heavyweight sectors generating substantial earnings growth for this year. That should help lift the broader market. It’s at least positive for the broader market. We have a little additional confidence built into those numbers, I think, because one thing that we’ve noticed is that capital spending, Capex, amongst S&P 500 companies, which is a pretty good proxy for broad Capex across the economy, has actually been creeping up. About a year ago the estimate for Capex for this year was around 3%, 4%. It’s now 7%. Interestingly, a study that came out recently from Gartner Group, which measures IT spending suggests that global IT spending is going to be about 7.6% higher than it was last year. This all comports for pretty robust technology spending and in that ecosystem around it. There are a lot of pundits suggesting that leadership is going to change and that some of the semiconductor stocks and other broad technology stocks have had their day. At the same time, those are the companies that are driving earnings growth and delivering earnings growth for shareholders. They, in our view, continue to warrant particular attention and investment. Looking Ahead In summary, earnings growth is a key part of stock prices and driving the market higher. From what we can tell, earnings growth forecasts are robust, and that’s positive for the broader market. We continue to favor secular growers within the market, particularly those that are in the early stages of new product cycles. The market can do okay, but we still want to be focused on those key areas where there’s relative outperformance in earnings and earnings growth. I threw a lot of figures at you today, if you want some of this data, feel free to reach out, 212-888-6403 or hit me with an email at tgardner@CJLawrence. We welcome your feedback, as always. In our next video, we’re going to talk about improvement in the industrial economy and the taking shape of the American manufacturing renaissance. Stay tuned for that. Feel free to contact me with any questions. Thank you.