Surprise! Fourth quarter results have been reported by roughly 80% of the S&P 500 and so far they are good. With 412 companies reporting (as of February 20th), year-over-year earnings growth is more than 16% according to Yardeni Research. Revenue has also grown with an 8.5% increase over the same period. From a market expectation standpoint, however, the significant percentage of companies that are surprising to the upside (76% for earnings, 78% for revenue) is more impactful. That is a larger than average number of companies reporting better numbers than analyst forecasts. The upbeat news for fundamentals doesn’t stop there. Guidance for 2018 is also moving higher. Usually, analysts give their most bullish view initially and then slowly ratchet down the expectation over time as the forecast period closes. This time there is a noticeable bump higher for the 2018 and 2019 estimates coinciding with the close of 2017 as company managements paint a rosy picture. And why not? Most forecasters simply take the recent past and extrapolate it into the future. We can call it the “line of sight” forecast method where whatever an analyst sees at the tip of their nose will extend as far as their eye can see. History clearly proves that wrong of course; the only constant in this world is change. The only question is when, and to be early is the same as being wrong (as the saying goes).
Regardless of the recent correction and near-recovery, the equity market has posted significant total returns in the trailing one year period. The US equity market (S&P 500) has gained over 16% as of February 21st outshined by Developed International (MSCI EAFE) up 21% and the Emerging Markets (MSCI EM) up 31%. What may be a surprise to many investors is that, despite these above average annual returns, the valuation on the next twelve months’ earnings (P/E) is generally lower than it was one year ago. Both the US and Developed International equity markets are roughly one multiple point lower than in February 2017 (17.3x vs. 18.2x in the US, 14.6x vs. 15.5x in Dev. International). Emerging market valuation is basically flat (12.9x vs. 12.7x). That bodes well if companies can perform. Delivering another solid year of equity returns after such a big run last year would be a surprise worth having.