Earnings Growth Top Not A Worry

Earnings growth is expected to peak in Q3 2018 which has already become a big story as investors have looked for bearish arguments since stocks have been flat or down for much of this year. This is a case of reaching for an argument which sounds good, but is completely wrong. The results have been good in Q1 and Q2 is shaping up to be great. There has been multiple compression which I expected this year as multiples elevated last year in anticipation of the tax cuts. However, stocks won’t decline because of slowing earnings growth.

In fact, the only time in the last 25 years that the peak in earnings growth occurred alongside the peak in stocks was Q1 2000. That also occurred when stocks were much more expensive than now; I don’t think we’ll see a repeat of that. Also, many of the stocks which rose parabolically during the tech bubble had no earnings. This bull market has been led by stocks with superior earnings growth. The latest update of Q2 earnings season is good as 9 S&P 500 companies have reported results and all 9 firms have beat their estimates.

The average Q2 earnings growth is now 29.1%. The blended average earnings growth which includes estimates and those 9 reports is 18.5%. That figure is likely too low. Estimates for Q3 and Q4 increased which is great for stocks and boosts the case for them to exceed the January highs. Earnings are pushing up stocks while the trade war rhetoric pushes them lower. Next week 11 companies report earnings. We aren’t in the meat of earnings season, but these results still are very important.

Predicting The Next Correction

I’m not expecting another correction since earnings look very strong. The biggest negative for stocks right now is the potential for a trade war. Even with a weakening global economy and a flattening yield curve which is hurting the banks, stocks have been mostly resilient in the past 2 months. The recent weakness this week could be enough to consolidate the S&P 500 allowing it to power towards new record highs.