By Anora M. Gaudiano, MarketWatch
Will tax cuts percolate through to boost economy?
It's still early, but so far fourth-quarter earnings season is
confirming what most investors had already suspected: a lower
corporate tax rate is likely to boost profits and may even
percolate into the broader economy.
As of Friday, 11% of S&P 500 companies had reported earnings
with two thirds of them beating estimates and about a fifth coming
in below expectations, according to FactSet. Analysts polled by
FactSet expect earnings grew 9.5% in 2017, while revenues grew
6.2%.
But it's the guidance from companies, especially regarding the
tax cut, that investors will continue to closely monitor.
"We are finally hearing from companies themselves of what they
will do with the tax windfall. And so far it looks like they plan
to spend about a third on wages or benefits to employees, a third
on capital investments and another third on share buybacks," said
Maris Ogg, president at Tower Bridge Advisors.
"This makes us believe that the tax cut is likely to have a
longer-lasting positive impact on the economy because of a
multiplier effect of higher wages, while companies will give back
to consumers by lowering prices," Ogg said.
Expectations of higher profits and continued economic growth is
perhaps a reason behind continued rally in the stock market, with
all of the main benchmarks sitting at record levels.
Read:It's 'happy new FOMO' for stock market as investors pile
in, says Merrill Lynch
(http://www.marketwatch.com/story/its-happy-new-fomo-for-stock-market-as-investors-pile-in-says-merrill-lynch-2018-01-19)
The S&P 500 closed at 2,810.30 on Friday
(http://www.marketwatch.com/story/stock-futures-rise-as-traders-shrug-off-government-shutdown-fears-2018-01-19),
an all-time high, gaining 5% so far this year and 24% over the past
12 months. That was the 10th record close so far this month,
matching the tally from January 1987 and one shy of the record for
record closes set in 1964 with 11.
Once the tax cut bill was passed late last year, Wall Street
analysts also ratcheted up their earnings growth expectations for
2018, according to John Butters, senior earnings analyst at
FactSet.
The consensus estimate for S&P 500 earnings growth in 2018
is 18.6% which would bring earnings to $151.55 per share.
Meanwhile, analysts expect 6% revenue growth in 2018.
But all of that optimism is now baked into the lofty valuations,
according to Ogg.
"The expansion in valuations was justified once the tax bill was
passed. But the easy money has now been made. Earnings growth needs
to keep up for stocks to go higher," Ogg said.
Read:Stocks look pricey, bonds look pricey. Is it time for
investors to consider cash?
(http://www.marketwatch.com/story/stocks-look-pricey-bonds-look-pricey-is-it-time-for-investors-to-consider-cash-2018-01-19)
While prices have been rising, so has volatility. Implied
volatility on the S&P 500 as measured by the Cboe Volatility
Index, or Vix, rose above 12 last week for the first time since
November. On Friday, the Vix closed 6.8% lower at 11.38.
In the next month or two, investors will begin to focus on the
outlook for earnings beyond 2018.
"What has been driving earnings growth today may turn into
headwinds tomorrow, so it will be harder to get the same kind of
[price-to-earnings] expansion we saw last year," Ogg said.
The price-to-earnings ratio based on the next year's estimated
earnings is currently at 18.4, well above the 10-year average of
14.2 and the five-year average 15.9, according to FactSet.
The more widely used cyclically-adjusted PE ratio, or CAPE,
which smooths out earnings over the previous 10 years and accounts
for inflation, is currently at 33, the second-highest level after
the dot-com boom in 2000.
"It is not the best time to increase exposure to U.S. equities,
but high valuations are also not a reason to avoid them. At this
stage we are more concerned about signs of speculation, rather than
a recession," Ogg said.
See:Why some investors say stock-market 'euphoria' calls are
premature
(http://www.marketwatch.com/story/stock-market-runs-hot-but-is-it-really-euphoria-2018-01-17)
Next week, 79 of the S&P 500 companies are scheduled to
report results, including nine Dow components: Johnson &
Johnson (JNJ), Procter & Gamble Co (PG), 3M Co.(MMM),
Caterpillar Inc.(CAT), Intel Corp(INTC), General Electric Co (GE),
Verizon Communications(VZ), United Technologies Corp(UTX) and
Travelers Companies Inc.(TRV).
On the economic calendar, investors are likely to pay attention
to existing and new home sales due on Wednesday and Thursday
respectively at 10 a.m. Eastern. Durable goods orders and gross
domestic product data are scheduled for Friday at 8:30 a.m.
Eastern.
(END) Dow Jones Newswires
January 20, 2018 08:01 ET (13:01 GMT)
Copyright (c) 2018 Dow Jones & Company, Inc.