We kick off fourth quarter earnings next week. We’ll hear from the big four banks on Tuesday and Wednesday.
As I’ve said coming into the year, the table has been set for positive surprises on earnings. The expectations were dialed down as confidence (particularly business confidence) eroded over the past half year from the uncertainty on trade.
That said, on Wednesday, China’s top trade official to travel to Washington to formally sign the “Phase 1” agreement.
And with the improved outlook on trade heading into the end 2019 (“improved” relative to what had formerly been an outlook of an indefinite trade war), even the Atlanta Fed’s GDP estimate (incorporating Q4 data) has risen to 2.3%. For context, in mid November, the projection was for sub 1/2% growth for the fourth quarter.
So what about earnings?
The market is looking for 2% contraction in Q4 earnings (year-over-year).
According to FactSet, in September, the market was looking for 2.5% earnings growth for Q4. So, again, we head into earnings season with expectations that have been dialed down. They’ve been dialed down because business confidence waned. Business confidence waned because of the perception of a never-ending trade war.
That script has since changed. So the table is set for positive surprises.
Now, let’s incorporate this view into the valuation on stocks, as we end the week after printing new record highs.
The market goes out at 18.5 times forward earnings (earnings expectations for the next 12-months). That is still cheap, considering we have a 10-year yield, still, at 1.8% (ultra-low levels). As we’ve discussed, historically when rates are at low, valuations on stocks tend to run north of 20. We’ve discussed this analog for the four years I’ve been writing this note. And for the four years I’ve been writing this note, rates have remained low, and the P/E on stocks has indeed expanded to 20 or above to end the year. If the market is, again, underestimating earnings, then the market is cheaper than it appears, at even 18.5 times forward earnings.