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October was a stormy down month. November, despite ending up 2%, was a rollercoaster-like month and December is shaping up to be another volatile month. Investor confidence has been shaken. Now would be a good time to look at fundamentals that underpin the market and it doesn’t get any more basic than earnings. At the end of the day, earnings and earnings projections are an integral part of what drive market returns – the price of a stock is based on investors’ expectations that the company will deliver positive earnings, either now or in the future. We are going to examine the 3rd quarter earnings results with 99.6% of the S&P 500 companies reporting.
In Q3 of 2018, the percentage of S&P 500 companies beating earnings came in at 70.2%, while misses were 20.1%, and in-line registered 9.7%. The chart below shows the S&P 500’s historical beats and misses since the 2nd quarter of 2012.
In the 3rd quarter of 2018 on a sector level; Information Technology, Utilities, and Consumer Discretionary had the highest beat percentages booking 90.2%, 82.8%, and 80.7%, respectively. All sectors had beat percentages outpacing misses, but Real Estate had the highest percentage of misses coming in at 31.3%. This makes sense as recently rising interest rates have put additional pressure on the Real Estate and Housing areas. We can see this in the following chart, ranking the S&P sectors by beat percentage from highest to lowest.
Of course, earnings “beats” are subject to analysts’ expectations, and if the bar is set too high, the data may be skewed to the downside. Investors should always look beyond the headline “beat/miss” news and look for insight on growth and profitability. Encouragingly, S&P 500 Sales Per Share rose a healthy 10.7% Year-Over-Year indicating that sales are moving ahead at a robust pace. Quarterly Operating Margins for the S&P 500 were up 12.2%, which as a 19.7% increase over the same quarter a year ago. Both metrics indicate healthy and robust growth.
And while the equity and bond markets have been volatile it looks like this volatility has helped to mute expectations for how many more hikes we can expect in the Federal Funds rate. The following chart shows how the probability for a rate hike at the December meeting has fallen with the volatility we have experienced so far in December.
While odds still favor a ¼% hike at the December meeting, further rate hikes look less certain following Chairman Jerome Powell’s dovish speech on November 28th, when he said the policy rate is now “just below” estimates of a level that neither brakes nor boosts a healthy economy, comments that many took as signaling the Fed’s three-year tightening cycle is drawing to a close.
Rates are still historically low and concerns that investors will suddenly abandon equities for fixed income may be overstated, particularly if U.S. companies can continue their strong earnings growth. If we consider that stocks in the S&P 500 “yield” approximately 5% annually in earnings, bond yields still do not offer a high enough return to push investors out of the equity markets.
So, while the markets have been painfully volatile, the earnings growth and sales are trending upwards. Weathering the storm can be challenging, but a disciplined approach based on economic fundamental data is necessary in volatile times like these.Download PDF
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