Banks unofficially kicked off the first quarter 2018 earnings season on Friday with results from JPMorgan, Wells Fargo and Citigroup. All beat due to a combination of volatile Q1 markets, tax reform, interest rate normalization and robust economic growth, but investors weren’t sure how they felt about those numbers, with those stocks initially rising on the news then falling..
Part of Friday’s fluctuations had to do with great expectations that are already baked. We’ve heard for sometime this is going to be the best earnings season in 7 years, so companies are going to have to put up some big beats to get anything out of these reports. Even meeting expectations might have a negative impact on a company’s stock when the stakes are this high. Earnings were always expected to do well as companies have a lot of cash on their balance sheets and the underlying economy is doing well, but the announcement of tax reform in December prompted 75% of S&P 500 companies to boost guidance even higher. Many have come out with detailed plans of how they will spend that money, meaningfully increasing Capex and R&D spending for the first time in years, improving employee 401k benefits and issuing one time bonuses, and increasing share buybacks and dividends.
The S&P 500 index is expected to see EPS grow 17.5% year-over-year (YoY) with revenues increasing 8%, the best numbers since Q2 2011. The sectors driving growth are energy and materials (still due to easy YoY comparisons), followed by financials and information technology, the two largest sectors by market cap. The sector with the lowest expected profit growth rate is consumer discretionary at 6%.
Current index levels and robust earnings expectations for 2018 suggest that stocks are fairly valued, maybe even cheap when adjusting for low interest rates. S&P 500 forward 12-mo P/E hovering around 17x, the 20-year historical average. If we stay at this level is heavily dependent on current earnings expectations being achieved.