After a near double-digit rally in US stocks since Donald Trump’s election victory, the question for investors is whether the outlook for corporate profits can begin to justify investors’ newfound optimism.
Much of the rally has been underpinned by hopes that a Trump administration will boost corporate profits through lower corporate taxes, a more accommodative regulatory regime and a more confident US consumer.
Corporate chief executives will be pressed on their view during fourth-quarter earnings season, which begins next week with the results from half a dozen S&P 500 groups, including some of the largest US banks. *
For money managers, five themes dominate as they wrestle with a Trump rally, on the one hand, and a price-to-earnings ratio on the S&P 500 that is at the highest level since the dotcom bubble.
1. The glass is half full on Wall Street
Wall Street, whose army of sellside analysts had warned about the pressure the stock market would come under if Mr Trump won, is changing its tune.
Investors are pencilling in an 11.5 per cent rise in earnings from S&P 500 companies for 2017 compared with 2016. A chunk of this is thanks to a rebound in the oil price, which is expected to help earnings from the energy sector. Even so, analysts expect financials, technology, healthcare, consumer staples, industrials, telecoms and materials to deliver earnings growth this year.
Given that, investors will closely scrutinise what chief executives have to say on the outlook for revenue and, ultimately, end-demand. With the Trump administration keen for US companies to invest in their domestic market, any word from boardrooms on potential plant and research spending will also be closely watched.
Wall Street analysts always tend to see the glass as half full, and their attitude towards the Trump administration is no different. Fourth-quarter positive earnings guidance — when a company predicts profits above the mean estimate of analysts — is above its five-year average.
“There’s a high probability that we see upward revisions to earnings based on fiscal stimulus and greater business confidence,” adds Kate Moore, chief equity strategist at BlackRock. “If that happens, the current market multiples will not necessarily look demanding and people may be more comfortable buying large-cap [stocks].”
With high expectations comes the risk of disappointment. Citi strategists warn there is some scope for that given it remains unclear what exactly the Trump administration will be able to get through Congress this year.
2. Dollar gatecrashes the party
If the prospect of lower corporate taxes and friendlier regulators is cheering equity investors, a strengthening dollar is not. The US currency has raced to 14-year highs on expectations the Federal Reserve will have to quicken the pace of rate rises to contain inflation.
That, in turn, has rekindled concerns of the potential hit to the revenues of multinationals from a stronger US currency. More than two-fifths of sales from S&P 500 companies were generated outside the US in 2015, according to S&P Dow Jones Indices. Then S&P 500 businesses suffered a hit in excess of $100bn as they translated sales made abroad back into dollars.
Adrian Helfert, the head of global fixed income at Amundi Smith Breeden, says that a stronger currency makes US exports “more expensive”. “The impacts may hurt corporate sector revenues,” he adds, and weigh on margins.
Strategists at JPMorgan Asset Management took a more optimistic view, arguing that while the dollar will drag on US exporters, tax reform and faster economic activity would more than compensate.
3. Has the world really changed for banks?
Several Wall Street behemoths, including Bank of America, JPMorgan and Citigroup, have already signalled that the trading environment since the election has been particularly fruitful. With banks starting to report results next week, investors and analysts will scrutinise what management has to say about the durability of this backdrop and the effect rising interest rates are having on the bottom line.
Earnings are forecast to rise for the financial sector by 11 per cent in 2017, as net interest margins — a measure of the gap between what banks borrow and lend at — improves, according to FactSet. In the fourth quarter, earnings are projected to be 14.5 per cent stronger than a year ago.
Investors, though, have not wasted any time in buying into a view that life will be better for banks under Trump. The S&P 500 banks index has risen 23 per cent since the election.
4. A confident energy sector
For the first time in several quarters, the energy sector is no longer expected to be a drag. Fourth-quarter profits are forecast to be almost where they were a year ago.
If the bottom line is projected to have stabilised last quarter, it is forecast to be in a much healthier state in 2017. The industry is projected to more than triple earnings this year, while rating agencies S&P Global and Fitch anticipate defaults to drop.
The swoon in the oil price, which began in 2014, forced many producers to curtail output and in November prompted Opec to agree the first supply cut in almost a decade. Now, with the crude price rebounding, investors will be especially keen to hear if US oil companies are ready to lift production and investment.
James Paulsen, the chief investment officer of Wells Capital Management, is recommending his clients go overweight the sector.
5. The return of corporate pricing power
During the last US quarterly earnings season, several companies raised the prospect that emerging wage pressures are beginning to crimp margins. The hope for shareholders is that a steady increase in incomes will continue to bolster spending.
Figures due on Friday will offer some clues as to whether the trend of rising wages remains intact. Torsten Slok, chief international economist at Deutsche Bank, argues many of the proposals from Mr Trump could support wage growth across a variety of sectors. If true, it would allow companies to pass on higher costs to customers, handing businesses the pricing power that has remained out of reach this cycle.
* This article has been updated to reflect that Alcoa is not among the companies set to report results next week
