U.S. companies are reporting their best profit gains in more than seven years and a record number are beating Wall Street forecasts — so why are stocks not responding?
The muted response to first-quarter earnings suggests that, against a backdrop of rising borrowing costs and other factors that could drag on profits, investors are beginning to worry that a turn in the business cycle may be in sight.
“Investors are looking at the gains in earnings and saying, ‘Great, we knew that, but what will you do going forward?’” said William Norris, chief investment officer of CIBC Bank USA.
With just over half the S&P 500 (.SPX) having reported, the largest U.S. companies are on course to show earnings per share growth of 23.2 per cent from a year ago, according to FactSet’s blend of actual and forecast results. That would be the highest rate of growth since the third quarter of 2010.
Seventy-nine per cent of companies reporting so far have beaten analysts’ forecasts. Most companies can massage expectations to arrange a beat, but this year’s rate is ahead of a five-year average of 70 per cent. If it holds up, it will be the highest since FactSet began tracking beat/meet/miss data in 2008.
Optimism over profits had been high heading into the reporting season, said Matt Forester, chief investment officer of BNY Mellon’s Lockwood Advisors, who calculated the Trump administration’s December cut in the corporate tax rate accounted for about 7 percentage points of the rise in profits.
“We have had a really gigantic surge in expectations over the last quarter or two, particularly when the news of the tax cut came into play,” he said.
Some earnings reports have included hints of rising costs, and Caterpillar, the construction equipment maker, said last week that its first-quarter earnings would be the “high watermark for the year”, spooking the market.
“There are some factors that could erode profits in the future,” said Mr. Forester. “That is why you see some concern about wage growth, higher rates and increases in commodity prices. You have to wonder if we’re seeing the peak earnings growth rate.”