Insider Q&A: Should investors worry about 'peak earnings?'

AP News
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Posted: May 20, 2018 12:01 PM
Insider Q&A: Should investors worry about 'peak earnings?'

NEW YORK (AP) — Speaking about a peak suddenly made stocks weak.

Investors got a rude awakening in April when executives at Caterpillar said the construction and mining equipment company didn't expect to top its first-quarter profit for the rest of the year. Other companies warned about paying more for fuel and basic materials, at a time when interest rates are the highest they've been in more than three years. All that has some investors worried that profit growth will slow down and pinch stocks.

But experts say what matters is that profits will keep growing, as will the economy. Sam Stovall, chief investment strategist for CFRA, said that based on the state of the economy and recent history, company profits should keep rising throughout 2018 and 2019 at least.

Comments have been edited for length and clarity.

Q: What's the significance of peak earnings to the market?

A: Since the reason investors invest is to get a cut of the action, and the corporate action is growth in profits, investors are under the mistaken belief that prices peak when earnings peak. History says that's not the case. For instance, current estimates jaypoint to the first quarter of 2018 as having the highest year-on-year growth in S&P 500 earnings per share at nearly 23 percent. Subsequent quarters are expected to be above 18 percent for the remainder of this year, but hovering around 10 percent for all of 2019.

We're not heading into an earnings recession, which has typically preceded an economic recession. We are just resetting the trajectory of earnings growth.

A corporate slowdown does not imply a contraction. It simply means that the year on year rate of change will be slowing.

Q: What are the biggest reasons profit growth will slow over the next year or two?

A: First it's what you would call easy comparisons. We had such strong growth early in this bull market because we recorded the first actual loss in the S&P 500's history in the December quarter of 2008. Having a strong period makes the next period more challenging. And we got a shot in the arm from the tax law change. We don't really see having that kind of similar jolt in 2019.

Q: If we're at a peak in earnings, what does that say about the state of the bull market and economy?

A: It implies that the best growth is behind us. People love to use that baseball game analogy, so you could say we are at or slightly beyond the seventh inning stretch, but what we don't know is whether the game will go into extra innings. We are currently in the second-longest bull market since World War II, and give us a few months and it will become the longest.

When we look to such economic indicators as housing starts, consumer confidence and the yield curve, none of them is telling me that a recession is imminent.

My feeling is that global economic growth as well as US economic growth is expected to be rising 2019 relative to 2018.

Q: How long does earnings growth usually continue after a peak?

A: On average we've had growth last a minimum of four years. Now we're expected to peak this quarter, but we're expected to be in double-digit growth through the end of 2019.