The Bull Market In Stocks Is In Jeopardy
(Bloomberg View) -- U.S. business optimism has hit rarefied air. That, in turn, has led to expectations for record earnings. But is all this enthusiasm masking signs of strain? Perhaps. With just a few weeks to go until first-quarter reports start flowing in, the bar is as high now as it is during normal economic periods. If companies fail to keep up with analysts’ lofty expectations, the markets are likely to experience another bout of rising volatility.
The charts below detail sentiment among large-company chief executive officers, small businesses and consumers. Collectively, they show optimism is extremely high, presumably on the heels of cuts in regulations, tax reform and a White House promoting a pro-business environment. The first chart is of the Business Roundtable’s first-quarter survey of large-company CEOs. It shows record-high business optimism in data going back 15 years.
Smaller businesses are feeling good, too. The National Federation of Independent Businesses, a trade group with more than 325,000 members, said its monthly Small Business Optimism Index shown below reached a 35-year high in March.
The NFIB also asks its members if it is a “good time to expand.” This question yielded the most positive result in its 44-year history.
Consumers are also very optimistic. A Conference Board survey shows consumer confidence is near an 18-year high. Consumer confidence correlates to a rising stock market and lower gas prices. The relentless stock market rally through the end of January had consumers feeling flush.
Given such optimism, it’s not surprising that earnings expectations have rocketed higher. What is surprising is the degree to which forecasts have increased. FactSet had this to say last month about record positive earnings per share guidance:
Over the past several weeks, have S&P 500 companies been as optimistic as the industry analysts in terms of their annual EPS guidance for 2018?
The answer is yes. From December 31, 2017, through February 15, 127 S&P 500 companies have issued positive EPS guidance for 2018. This number is more than double the 10-year average of 49 for this same period.
In fact, this number marked the highest number of S&P 500 companies issuing positive EPS guidance for a year (through this point in time) since FactSet began tracking guidance data in 2007.
Wall Street is taking notice. The next chart shows Bloomberg’s estimate for growth in first-quarter operating earnings compared with a year earlier. After the corporate tax cut was passed in mid-December, forecasts jumped from 11 percent to almost 17 percent. A rise of this magnitude so far ahead of the start of earnings season has no historical precedent.
The chart below shows the blended growth rate for S&P 500 earnings for the last 13 quarters. As companies report, the estimate is replaced with the actual result. The last point (dot) in each series consists of the 500 actual results. The black line on the right side of the chart shows the 500 estimates for first-quarter 2018 earnings growth. Thomson Reuters I/B/E/S maintains a similar set of data going back to 1979. Excluding the years immediately following a recession when earnings are rebounding from a highly depressed level, a growth rate of this magnitude has never occurred.
The chart also notes another anomaly in earnings estimates. Typically, they start out high and fall as companies guide analysts’ expectations lower. This allows companies to beat estimates once earnings season begins. The vertical gray lines in the chart above roughly indicate the beginning of each reporting season. As can be seen in almost every series, earnings estimates bounce higher once companies begin reporting. First-quarter 2018 earnings estimates, shown in black in the chart above, have broken this pattern. Estimates have been rising for several months.
But will companies still be able to beat expectations as they have every quarter since the Great Recession? Last week, Factset pointed out these statistics:
At this point in time, 103 companies in the index have issued EPS guidance for Q1 2018. Of these 103 companies, 51 have issued negative EPS guidance and 52 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 50% (51 out of 103), which is well below the 5-year average of 74%.
If 52 is the final number of companies issuing positive EPS guidance for the first quarter, it will mark the highest number of S&P 500 companies issuing positive EPS guidance for a quarter since FactSet began tracking EPS guidance in Q2 2006.
In other words, companies are not backing down from these lofty expectations. So this quarter will have to be one of the best ever to be considered a success. Anything less could further boost volatility from elevated levels.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Jim Bianco is the President and founder of Bianco Research, a provider of data-driven insights into the global economy and financial markets.
For more columns from Bloomberg View, visit http://www.bloomberg.com/view.
©2018 Bloomberg L.P.