Global Market Commentary

Earnings Are Strong, And It’s Not Just Tax Cuts

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Quarterly earnings are in full swing, affording investors one of their periodic views into the financial performance of a wide spectrum of companies, and the chance to hear some valuable anecdotal comments from company management about the state of their businesses, their industries, and the wider economy.  Here at Guild, we listen to a lot of company conference calls during this time — both for stocks owned by our investment management clients, and for bellwether stocks that can provide useful information about the current economic and market environments.

Usually earnings season passes without really affecting the mainstream, non-financial news.  Facebook [NASDAQ:  FB] broke that pattern this quarter as it reported results showing that its big ramp-up in spending on security could start to eat into margins in coming years.  The FB disappointment has reverberated through the rest of the high-growth technology leaders, dampening the reaction to positive results from other tech companies such as Alphabet [NASDAQ:  GOOG], Amazon [NASDAQ:  AMZN], and Apple [NASDAQ:  AAPL].  The tech leaders may be under pressure or lag for some time; new leadership may emerge, or tech may return to leadership as it has throughout the post-recession bull market.  Each week in our Market Summary we keep readers abreast of our views about these rotations.

Source:  Bloomberg Finance LLP

Aside from the news flow for specific companies, though, the big picture for U.S. earnings remains very strong.  The Nasdaq 100 — the index that includes the big-tech growth titans — is just 3% down from its all-time highs.  The August/September period is here, which is often unpleasantly volatile for stocks.  Domestic political worries remain present as campaigning continues for U.S. mid-term elections in the fall.  Foreign relations remain as unpredictable as they have for most of the past two years.  In the face of all of this, it is important to keep an eye firmly fixed on the main driver of stock appreciation, which is corporate earnings growth.

In that light, here are some bullet points about the current earnings season:

• The preliminary report for second-quarter GDP growth last Friday was stellar: 4.1% on an annualized basis, a level that has rarely been hit in the post-2007-2009 recession period.  We believe that a sustained improvement in trend GDP growth is possible, and that in the midst of the chaos and disruption that has characterized much of the current administration’s modus operandi, policies to support it are being put in place.  GDP growth is the fundamental driver of earnings growth.

• Although since FB’s earnings report, tech stocks have underperformed the broad market, tech companies are outperforming on earnings.  Excluding the benefits of tax reform, S&P tech sector earnings are up 23.8% year-on-year, versus 15.5% year-on-year for the S&P as a whole.  Only the energy and materials sectors are showing better earnings growth.  (We excluded energy’s 110.9% earnings growth rate from the chart below in order to show the other sectors in better detail.)

• On the subject of taxes, we note that even when tax benefits are taken into account, earnings growth is extremely strong.  We emphasize this because a common narrative is that currently strong earnings growth is simply a creature of tax reform and not a result of underlying strength in the economy, and among businesses and consumers.  We note further that tech is particularly strong in its underlying earnings growth — i.e., reported earnings are only being helped modestly by tax reform.

Data Source:  Credit Suisse

• The earnings-growth story is strong, and so are the surprises — that is, whether companies exceed the expectations that analysts have before earnings are announced.  Nearly 80% of companies that have reported thus far have beaten revenue estimates, and earnings on average are beating estimates by 4.8%.

Investment implications:  Economic growth is strong, and as second-quarter earnings reports come in, revenues and earnings growth are also very strong.  The earnings growth that companies are reporting is not just an artifact of tax reform; even taking those benefits into account, it’s very strong.  The leadership of technology stocks has been clouded by Facebook’s recent disappointing earnings report, but tech earnings are in fact showing some of the greatest strength, and that with a relatively small contribution from tax reform.  We continue to like the big tech leaders and welcome the opportunity to buy some of them at slightly lower valuations.  We believe that it is likely that they will eventually return to leadership.  Please note that principals of Guild Investment Management, Inc. (“Guild”) and/or Guild’s clients may at any time own any of the stocks mentioned in this article, and may sell them at any time.  Currently, Guild’s principals and clients own AAPL, AMZN, FB, and GOOG.  In addition, for investment advisory clients of Guild, please check with Guild prior to taking positions in any of the companies mentioned in this article, since Guild may not believe that particular stock is right for the client, either because Guild has already taken a position in that stock for the client or for other reasons.