Q1 2017 Earnings Season has arrived, and it is getting plenty of scrutiny.
Several factors have all converged to magnify the importance of this quarterly report card for U.S. stocks. The results of this quarterly will certainly impact the overall direction of the market, and will create winners and losers within the sectors. Why is there such interest this quarter? The short answer is lofty valuations, Fed interest rate increases, and political winds.
Here’s a quick breakdown on these factors impacting Q1 2017 Earnings Season:
The market overall has had a nice run for the last few years. This has led to price earnings ratios (P/E) increasing. This is the most watched valuation metric – and normally the P/E ratio sits around 15. That means that people are willing to pay 15 dollars in share price for every dollar of earnings. Right now Ed Yardeni of Yardeni Economics reports that the Forward P/E is 17.4% for the S&P 500. When the P/E ratio goes above 15, a couple of dynamics come into play: one, it means that the market is expecting future earnings to grow at a faster than normal rate, and two, if the market (or individual stocks) don’t live up to expectations their price can fall sharply.
Right now, Thomson Reuters reports that analysts are expecting 10% year over year earnings growth for the stocks in the S&P 500 for Q1 2017 earnings. The dirty little secret is that EVERY quarter more companies will beat earnings expectations – so if this trend holds, there will be a double digit increase in earnings for the companies in the S&P 500. That would help to justify our currently lofty valuation. On the other hand, if companies’ don’t hit their estimates, they will usually be punished with pretty severe price correction – sometimes called the price impact of the negative earnings surprise.
Interest Rate Increases
The Federal Reserve has begun to raise short-term rates. While long-term rates really haven’t followed along, they can’t be too far behind.
Interest rates increases create winners and losers. The financial sector usually will benefit from these raises, because they immediately charge their customers more for short term loans, while they don’t immediately raise the interest rates they pay out on their bank deposits. Thomson Reuters reports that the financial sector is expected to grow earnings at a 15% rate this quarter. Therefore, those banks that beat this high bar will be rewarded.
The new administration came in with promises that would create winners and losers in various sectors. For example, there were promises of increased spending on defense and infrastructure. As a result, these companies saw some significant price increases. With those price moves, however, come increased expectations. So this quarter (Q1 2017 earnings) will really be the first quarter that they will be judged. Their P/E ratios have increased, will their earnings growth match this valuation?
So fasten your seatbelts and grab your popcorn! Q1 2017 earnings will be a fun quarter to watch, and be ready to make adjustments as the impacts become clear.