The gloom that started to bite into the earnings estimates for US S&P 500 companies half a year ago and was a factor in the late 2018 equity market correction has now largely dissipated, with many companies posting better-than-expected results. In all fairness though, while optimism has returned, this is only so to a limited extent.
Caution still prevails, even if the outlook for interest rates has pivoted away from expectations of more policy tightening by the US Federal Reserve to no such further action or possibly even a rate cut this year. Worries include the timing of the eventual end of the decade-long US economic expansion, the chances of a resolution to the standoff with China over trade, and geopolitical tensions and their impact on oil prices.
Returning to the expectations for earnings per share, back in September, the forecast stood at just under 8% year-on-year EPS growth. It then skidded to as low as almost -4% in the first quarter before recovering to roughly 1% by mid-May. It is fair to say that the feared US earnings recession did not materialise.
Exhibit 1: Earnings optimism has returned, first and foremost in the US – next-twelve-month EPS estimates
(indexed: 15 May 2018 = 100; MSCI indices except Nasdaq)
Source: FactSet; data as 15 May 2019
Indeed, many US sectors did better than was expected last autumn. Consumer discretionary, financials, communication services and real estate were in the lead. Industrials disappointed, however, and more so information technology where the impact of weak semiconductor prices (DRAM -21% YoY) and destocking outweighed the gains in software and services.
With the exception of energy and materials, sales growth across most US sectors translated into earnings growth, pointing to the support from improving margins for EPS. For European companies, however, the story has not changed: margins remain an issue as earnings growth lags sales growth, although margin forecasts are steady, even in the face of rising wages.
In Japan, by contrast, all sectors except utilities are still suffering, with industrials, telecommunications and real estate having the toughest time. On the other hand, the price/earnings ratio is well below average, while it is about average for Europe. The even more-above-average P/E for the US reflects the better (than expected) earnings and sales growth there.
To sum up, analysts’ forward EPS estimates for the US have recovered all their losses – a move that has also been reflected in market gauges such as the S&P 500 and the Nasdaq. Other markets have yet to see earnings optimism return fully, lagging by varying degrees.
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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.