Profits over Politics
As investors, the best thing about earnings season is it filters a lot of the other noise out of the market. A month ago, a tweet, tariff headlines or even a longshot tax proposal would have moved the equity markets. But now that we are in the throes of earnings season, equity investors are focused on the most important factor in investing: earnings.
After a month of first quarter earnings, we have seen a robust reporting season. While we expected the earnings recession to be over, the first quarter has been strong. As of April 28, 58 percent of the S&P 500 companies have reported first quarter earnings and year-over-year growth has come in at just over 12 percent. The two largest sectors according to profit have shown the best growth with technology delivering 16 percent growth and financials printing 18 percent. Can companies keep up this pace? We don’t think so, and for one reason: the majority of consumer retailers have yet to report and that has been a weak spot with respect to earnings. However, the strength we are seeing in the first quarter has resulted in the full year 2017 earnings to be revised slightly higher, rather than lower, as they historically have been.
Long-time readers and clients may recall our commentary on the infamous FANG (Facebook, Amazon, Netflix, Google/Alphabet) stocks 12-18 months ago. The 2015 returns for the S&P 500 were driven by concentrated group of large cap growth stocks, and any diversification away from that segment resulted in negative returns. 2016 correctly proved our theory that the market should broaden based on improving economic prospects as well as earnings. We are seeing follow through of that thesis into 2017, as highlighted earlier. However, those large cap growth names continue to deliver on the earnings front and investors are rewarding them with premium valuations (the chart below highlighting this factor). Although we are seeing broad-based earnings growth, the overall market is delivering solid returns as well.
What do we think of the FANG stocks now and our 2017 thesis? We continue to believe that balancing valuation and growth prospects is paramount but we are still constructive on the broad market as it offers better value than the large cap tech names. Also, with the turn in energy names (as highlighted by solid earnings from Exxon and Chevron), we believe a broad-based, diversified investment strategy will benefit clients throughout 2017.
Our Takeaways for the Week:
- First quarter earnings are coming in ahead of expectations justifying the rally year to date
- While large cap growth has been a winner, we believe the broad market will deliver solid gains with less risk in 2017