Strong US Sales to Ease Profit Concern into 2019
A healthy outlook for US revenue growth will assuage stock investors concerned about the effect on corporate profits from tax cuts wearing off next year.
S&P 500 (NYSEArca:SPY) revenue growth, which hit 9.5% in Q-2, its fastest pace since Y 2011, is estimated at 8.2% for Y 2018, according to Thomson Reuters data.
While that growth is expected to slow some next year, it is still at the high end of the historical average. The falloff is not as steep as that expected in earnings growth, which received a big boost this year from the Tax Cuts and Jobs Act that slashed the corporate income tax rate.
That could ease some investors’ concerns about profit growth, which is hitting its peak for the cycle this year, while risks are increasing from costs related to tariffs, rising interest rates and a strengthening USD.
“The revenue growth more than offsets any of the concerns we have on the earnings side,” said the global equity and technical strategist at Wells Fargo Investment Institute in St. Louis.
Yes, there is peak earnings growth, we had tax cuts, so what we want to see is sustainable earnings growth driven by the Top line, which is what we are seeing right now.
The revenue gains are being driven by strong demand from economic growth, with GDP rising at a 4.2% annualized rate in Q-2, the fastest in 4 years.
At least part of the boost to revenue is coming from the robust US labor market, while capital spending is also helping.
Data released Friday showed US wages in August notched their largest annual gainer in 9 years, suggesting consumer spending will continue to stay strong, accounting for 72% of the US economy.
Rising wages could become a risk to earnings at some point, but that might not happen until Y 2020.
Now the earnings story is a revenue story. It is allowing companies to continue to drive that bottom line growth, and it will be able to make up for any bump in the road from higher costs.
Most economists polled by Reuters in late August expected economic growth to edge off the recent 4-year high in the coming Quarters, but still saw little chance of a recession over the next 2 years.
The tax cut package, the biggest overhaul of the US tax code in more than 30 years, resulted in a surge in profit growth, creating a peak later in the earnings cycle than typically.
Analysts have forecast S&P 500 earnings growth at 23.3% for Y 2018 – the highest annual growth since Y 2010, and at 10.2% for Y 2019, based on Thomson Reuters data.
Earnings grew an estimated 24.9% in Q-2 from a year ago, and analysts expect growth of 22.3% for Q-2.
Results can continue to increase even after growth peaks.
For example, S&P 500 earnings growth peaked in Q-4 of Y 2003, yet remained in the double-digit range for at least 3 years after that, while revenue stayed well above trend in that frame.
Notably, in the last 80 years, S&P 500 earnings growth averaged about 6 to 8% a year, while sales grew about 3 to 5%.
Early indications are that this is looking like Y 2003, where we could see above-trend growth persist longer than consensus expects. And so, when we have this type of revenue growth, companies can extend above-trend profit growth.
|HeffX-LTN’s Analysis for SPY:||Overall||Short||Intermediate||Long|
|Bullish (0.44)||Neutral (0.24)||Bullish (0.33)||Very Bullish (0.75)|
Have a terrific weekend.
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