One big reason why stocks prices are holding up

Nicole Sinclair
Markets Correspondent
The New York Stock Exchange is seen from the steps of Federal Hall behind a Statue of former U.S. President George Washington in New York City, U.S., May 17, 2017. REUTERS/Brendan McDermid

Despite the heightened level of uncertainty in DC amid reports of turmoil and scandal in the Trump administration, the financial markets remain resilient with stock markets flirting with all-time highs.

According to analysts on Wall Street, a big reason for elevated stock prices is stellar earnings growth.

During the first quarter, earnings jumped 15% year-over-year. This was the highest pace of growth since the third quarter of 2011, Morgan Stanley’s Brian Hayes observed. The latest results are a welcome change, particularly due to the fact that growth had been negative through 2015 and the first half of 2016.

According to data from FactSet, 75% of companies reported earnings per share above estimates and earnings have beaten expectations by a margin of 6.0%. Both stats were above their 5-year averages.

This strength has been broad-based with telecoms being the only major sector that didn’t beat expectations. Notably, the laggards of 2016 have turned around.

“With energy prices substantially above last year’s lows, and the operating environment for financials on the mend, S&P 500 revenues and EPS are coming in much stronger,” RBC’s Jonathan Golub said. “Importantly, this is being delivered across almost all sectors, and is expected to continue throughout 2017 and into 2018.”

Revenues also grew 8% this past quarter, the highest since the first quarter of 2012.

And the tone of guidance, which is closely watched by analysts, has also been improving. The ratio of negative-to-positive guidance for next quarter was 2.15x, which is below the recent average of 2.6x.

Politics

Last week, the stock market saw its biggest one-day tumble of the year following reports that President Donald Trump asked then FBI director James Comey to drop an inquiry into former national security advisor Michael Flynn. But prices have since rebounded.

“With fundamentals continuing to improve stateside in the economy and with corporate earnings on the rise, it would appear in hindsight that last Wednesday’s mini drama was less of a harbinger of dark things to come but rather just a short-term reaction,” Oppenheimer’s John Stoltzfus said.

In other words, strong earnings seems to be the more important driver of the market right now.

“Although we admit that US political uncertainty has risen, fundamental supports are the expectation of robust earnings growth over the coming quarters and this projection does not factor in US tax cuts or spending increases,” JP Morgan’s Jan Loeys said on Friday.

Valuation

The stock market continues to look expensive with the price/earnings (P/E) multiple on the S&P 500 hovering at 17.3x, which is well above the long-term average of 14.2x. However, not everyone is concerned.

“Multiples are above average but do not represent a risk to stock price,” Golub said. In fact, he argued, “Multiples should continue to expand even though they are above average.”

Golub isn’t alone in arguing that valuations aren’t very troubling.

“Although most valuation metrics remain high, positive EPS revisions have helped sustain equity prices,” Goldman Sachs’ David Kostin said.

For stocks, it all comes back to earnings.


Nicole Sinclair is markets correspondent at Yahoo Finance.

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