Overview: A very strong economic backdrop looks set to deliver another round of positive earnings growth in the third quarter. The bar is actually quite low for Q3 earnings, which may support further stock market gains.
Wall Street records
First to note, stocks are heading into earnings season after notching a succession of all-time highs. U.S. stocks hit record highs Thursday as the S&P 500 completed its longest winning streak in four years.
The S&P 500 closed above 2,552 on Thursday to record an 8-day winning streak – its best run since 2013. A sixth straight record close was also its best run since 1997.
The Dow Jones industrial average added a further 113 points on Thursday for a fresh all-time closing high at 22,775. Dow 23k is now very much within reach.
Earnings are not the only driver here. After a soggy period for stocks as Trump’s healthcare reforms floundered, there is renewed hope that the president will see through some meaningful tax reform. The passing of a $4.1 trillion budget is a big leap forward on the road to tax cuts.
In short, US equities are enjoying strong bullish momentum coming into the Q3 earnings season.
Earnings have been strong so far this year, with EPS growth of 13.6% in Q1 and 11.1% in Q2, but according to Zacks Investment Research expectations for Q3 have declined to a mere 3.2%. As is customary, earnings expectations have been revised lower – down from 6.2% in June. This is less than usual.
Expectations for earnings are therefore solid but not excessively high, which means there is low bar to exceed expectations. Macro indicators are positive and the consensus forecasts for earnings in the third quarter may be a touch pessimistic.
Macro indicators are positive with the September PMIs recording multi-year highs. The ISM non-manufacturing gauge came in at 59.8, its best reading since August 2005. That was after the manufacturing index registered its best reading since 2004.
Valuations and volatility
Multiples continue to appear elevated although since earnings are picking up the increases have are less abrupt than the run of records on Wall Street could suggest. The Cyclically Adjusted PE Ratio for the S&P 500 is above 31 – as noted on many occasions it’s only be this high twice before.
Volatility remains incredibly with the Vix registering its lowest ever close at 9.19 on Thursday as stocks recorded all-time highs.