In their landmark 1934 book on value investing, Security Analysis, Professors Benjamin Graham and David Dodd observed that, in the short run, the stock market is a voting machine but that in the long run, it’s a weighing machine.
What they meant is that on any given day, a number of ephemeral factors can influence the popularity of a stock but that ultimately stock prices are driven by earnings and what investors are willing to pay for them. With roughly 90% of U.S. companies and 73% of non-U.S. companies in developed markets having reported results for the Q4 2017 earnings season,1 we have a clearer picture of how today’s earnings are shaping up and how analysts are adjusting their forecasts for 2018.
Raising the bar on U.S. earnings
In the United States, Q4 earnings growth came in at a solid 14.92%, led by large gains in commodity-driven sectors and technology. Even more compelling is the outlook for 2018, which analysts have pegged at 18.30%, nearly double the 10.81% earnings growth achieved for calendar year 2017. Stronger economic growth globally and the new tax law here at home are brightening the earnings outlook for a number of sectors, notably financials. Analysts have raised their 2018 earnings growth forecast to 27.26% for the sector, well above last year’s 7.21%. These forward-looking estimates were revised sharply higher at the start of the new year as analysts took stock of changes brought by the new tax law.
One risk for investors in U.S. equities is that the heightened expectations for 2018 earnings can lead to disappointments when companies fall short. That said, the asset managers and researchers in our network believe that earnings will remain supportive of stock prices in the year ahead.
More muted expectations for international companies
Developed non-U.S. markets saw a somewhat mirror image of what’s happening in the United States. MSCI EAFE companies are on track to generate a remarkable 50.67% earnings growth in Q4 2017 and 21.49% EPS growth for calendar year 2017. Earnings grew two times faster for international developed companies than for their U.S. counterparts last year; however, the estimates for the year ahead are a relatively modest 10.09%. These forecasts represent a much lower hurdle for companies to clear than in the United States, but are nevertheless strong. They’re also backed by low inflation and still accommodative central bank policy, whereas the U.S. Federal Reserve has clearly begun to pull back monetary stimulus.
Finally, Q4 earnings in emerging markets (EM) grew at a healthy 27.16% rate, led by industrials and with technology companies driving earnings growth for much of the year. With only one third of companies reporting, there is room for change, but the earnings outlook for EM companies remains both bright and balanced across sectors.
Today’s strong earnings backdrop is a key reason why we remain bullish on U.S. and non-U.S. equities over the next 12-18 months, as illustrated in Market Intelligence. Global earnings growth has reached a six and a half year high of nearly 20%. Equities could continue to track earnings higher in the coming months, or, should they stall, alleviate some of the pressure on valuations. Either way, the market’s weighing machine appears to have plenty of good news to evaluate at the start of 2018.