Decent Start to the Q4 Earnings Season
The first measures and executive orders of the new U.S. government under President Trump are currently dominating newspaper headlines. Financial market participants are therefore paying less attention to economic data and Q4 2016 company earnings results than is usually the case. They may be missing a good story: the Q4 reporting season has started well, confirming the turnaround in earnings growth that started in Q3 2016. The previous earnings recession had been largely caused by a strong move upwards in the US dollar and an oil price shock. These factors have gradually faded in the course of 2016.
Confirmation of the upward trend in earnings
At the time of writing, more than 200 companies with about 50% of the market cap in the S&P500 index have published their Q4 2016 results. The reporting season should therefore already paint a fairly reliable picture about overall market developments. Roughly 73% of the companies have delivered better results than expected and aggregate earnings growth of about 4% yoy is better than market expectations. The picture in Europe is still a bit more tentative and less reliable as only 15% of the companies in the Stoxx600 Index have so far published their results. About two thirds of them were able to beat expectations. In Europe, aggregate earnings growth is due to statistical base effects currentlycalculatedat21.7%yoyonsalesgrowth of3.4%.Despite differences in numbers, the overall trends in the U.S. and Europe are similar.
Eye-catching observations in the sectors
The oil price is still the decisive factor for developments in the energy sector. Earnings declines in this sector had last year been bigger than the oil price decrease but the sector is still struggling after the oil price recovery. Oil price developments probably also contribute to margin compression in the transportation sector. The telecommunications services sector seems to be confronted with continuing structural change and a highly competitive environment. Margin growth is therefore negative and weighing on earnings growth. Margin compression also prevails in the consumer discretionary sector, probably partly due to the fallout of the diesel emissions scandal in the automotive sector and highly competitive environments (due in part to the internet) in media and retail companies. A striking margin improvement and a pick-up in earnings growth can however be observed in the financials sector. An improved growth outlook and progress towards a more normal interest rate environment, with slightly higher yields and steeper yield curves, has probably improved business sentiment and activity in the sector.
Earnings are likely to continue to grow in 2017. The global economic growth outlook is improving and is expected to support business activity in the course of the year. Earnings growth on the U.S. equity market is expected to get a boost from a cut in the corporate tax rate. There are still a lot of uncertainties and it is not yet clear, for example, how much the U.S. corporate tax rate will be cut, but we estimate that every 5 percentage point cut in the tax rate from 35% would boost overall S&P500 earnings per share (EPS) by around 5 USD (~4%). The tax reform would probably be effective in the short term, as the benefits are front-loaded. Over time, however, some of the benefits are likely to be passed on to customers via lower prices. The EPS effects of other policy measures proposed by the Trump administration around international trade area – such as the border adjustment tax – are much more difficult to judge, as their impact is driven by a complex interplay between the respective tax rates, pricing power, currency movements and foreign and domestic supply/demand adjustments. Different sectors are likely to be affected in different ways. Overall, in the longer term, the impact of such measures affecting international trade could significantly reduce the positive EPS effects of the corporate tax rate cut.