2018 Earnings Estimates Are Likely Done Increasing

The Estimates Are Done Rising

The Q4 2017 earning season is now almost over. I will be reviewing the S&P Dow Jones numbers, but first let’s look at the chart which shows future expectations. With the GAAP earnings being hurt by tax related write downs in Q4, the future estimates are the most important aspect to review. As firms reported earnings, analysts updated their models with the lower tax rate. As you can see, there were sharp bumps in the estimates for 2018 and 2019. As the analysts were raising estimates, we wondered when the boost would be finished. I determined it would likely end when the earnings season is over. We’re seeing that situation play out. As you can see, the slopes of the curves have flat lined. I expect the current estimates to be near the peak of expectations since earnings season is 90% done. Now we’ll see declines as we get closer to the results like usually happens. Double digit earnings growth in 2019 is unlikely. Earnings growth around 15% plus or minus 1% is probable.

It’s very tough to determine what is priced in. I tweeted Jeffrey Gundlach about the 18% expected earnings growth in 2018 and he said it was priced in. The reason it’s tough to know what is priced in is because stocks rallied from the election until the tax cuts were passed based on the improving business environment. The stock market hasn’t rallied that much since the tax cuts were passed. You need to determine how much of the post-election rally was due to the improving economy in 2017 and how much was caused by the hope for tax cuts and regulation reform.

If the market is expecting $157.76 in S&P 500 earnings, stocks will fall this year because that number won’t be hit. However, the market’s expectations aren’t the same as what the analysts expect. If the two were the same, stocks that beat estimates would always rally and stocks that miss estimates would always fall. The market knew these estimates would increase right after the tax cut was passed. Stocks have rallied many times this cycle as the earnings estimates have fallen. As long as the growth after the decline in estimates is in line with the price increase, the multiple stays the same. To be clear, earnings matter, but the market is one step ahead of the analysts.