Forget Caterpillar Freakout, S&P 500 Profit Picture Looks Rosy
(Bloomberg) -- Caterpillar’s unexpected warning that 2018’s best days may already be in the books has equity markets on edge for a second day.
On the surface, that makes sense. The industrial behemoth ranks as a bellwether for the global economy and any sign that its profits have peaked may very well portend a slowdown in growth around the world.
But anyone panicking over peak earnings is overlooking the fact that results not only got a boost from tax cuts, but that company executives have struck an optimistic tone on conference calls at a rate rarely seen. Add to that forecasts for 10 percent profit growth in the S&P 500 for at least the next two years, and it’s possible to conclude the market freakout is overdone.
Because of tax distortion, earnings growth “is as good as it will get statistically, but the growth trajectory is still going to be solid,” Julian Emanuel, chief equity and derivatives strategist at BTIG LLC in New York, said in an interview on Bloomberg Television. “Are we going to do 25 percent again? Not likely. Can we do double digits and will that be sufficient? We believe so.”
A look at other assets shows that financial markets have exhibited few signs that economic growth is poised to slow. In fixed income, two-year Treasury yields just made a decade high while the spread between those yields and the Fed Funds rate hovers near 75 basis points -- a long way from forming the inverted curve that has historically foreshadowed economic recessions, according to Renaissance Macro Research.
“A big‐global name like CAT obviously has some unique insight into global growth and the health of the overall economy, but we take the comments in context,” Jeff deGraaf, Renaissance Macro’s co-founder, wrote in a note.
“If growth has peaked, we’d expect more fissures within fixed income markets,” he said. “Peaks in the cycle will tend to have already been telegraphed by an improvement in the relative performance of staples, utilities, REITs, it’s not happening yet.”
Even with major companies getting hit after reporting better-than-expected earnings and guidance, the prevailing bias on the equity market remains geared toward economically sensitive stocks. Consumer discretionary, tech and energy producers, companies whose revenues ebb and flow with the economy, have performed best in the S&P 500 this year.
Still, investors can be forgiven for over-reacting to negative management commentary at a time when economic data around the world are trailing forecasts and positive earnings surprises have seen muted reactions in stock prices.
Even Caterpillar’s stock movement is a reason for worry. The industrial heavyweight’s moved virtually in lockstep with the S&P 500 for the past two months. And with the bull market just a few months away from becoming the longest in history, skepticism naturally creeps up.
“For weeks, we all heard about how the earnings season was going to be the catalyst to take the market up to, and above its 2018 all-time record highs,” said Matt Maley, an equity strategist at Miller Tabak & Co. “Instead, it has so far been the catalyst for a decline that could be taking it down to retest its 2018 lows,” he said. “If earnings cannot stem tide, what can?”
Corporate executives, for their part, have remained upbeat. On earnings calls, the ratio of positive versus negative language used by management exceeded the historic average during the first two weeks of this reporting season, according to data compiled by Bank of America Corp. The firm’s model on management sentiment is tracking near record highs.
There are “no cracks yet in Corporate America’s rosy outlook,” BofA strategists led by Savita Subramania wrote in a note to clients Monday.
©2018 Bloomberg L.P.