END OF EARNINGS DECLINE IS NIGH
Earnings for the S&P 500 have registered five-straight quarters of year-over-year earnings declines through the second quarter of 2016. In that time frame, the index has largely been range-bound and flat, unable to break decisively above the 2,100 level.
That’s no coincidence. For stock prices, the No. 1 driver is earnings. When earnings aren’t rising, it’s difficult for stocks to climb.
Fortunately for bulls, the factors that drove the current “earnings recession” are coming to an end. That may finally drive earnings higher, pushing up the S&P 500 and ETFs tied to the venerable index, including the SPDR S&P 500 ETF (SPY), the Vanguard S&P 500 Index Fund (VOO) and the iShares Core S&P 500 ETF (IVV).
Oil & The US Dollar
Plunging oil prices (which depressed earnings for energy sector stocks) and a surging U.S. dollar (which weighed on profits for multinationals) were the two largest contributors to the earnings recession.
However, these factors will soon cease to be a drag on earnings growth. Oil has doubled off its worst levels of the year, and the dollar, while still elevated, isn’t surging like it was in 2014 and 2015.
In fact, year-over-year earnings growth may have already ticked up into positive territory. As of this writing, corporations are in the midst of reporting their third-quarter earnings. Depending on who you ask, aggregate Q3 profits for the S&P 500 could turn out to be higher than they were a year ago.
Declines Already May Be Over
FactSet is currently estimating a 0.3% decline, while Thomson Reuters estimates a 1% gain. As corporations tend to beat analyst expectations, it’s likely Q3 earnings will end up being marginally higher than they were a year ago, marking the official end of the earnings recession.
More importantly, most analysts see earnings accelerating in Q4, with year-over-year growth of more than 5%. Then in the full-year 2017, if the current optimistic estimates are to be believed, earnings may grow another 10% or more.
To be sure, analysts tend to be overly optimistic about earnings heading into a new year. But the bounce-back in oil prices and a modest improvement in profit margins may be enough to fuel the first notable jump in earnings in years.
The last time S&P 500 earnings increased by double digits was in 2011. If that happens in 2017, the market could surge, pushing the S&P 500 to 2,400 or more.