Via ConvergEx's Nicholas Colas,
Markets now swing on two anchors.
- One is “Before Trump” – those financial estimates and economic assumptions that existed before November 9th, 2016.
- The other is “After Trump” – the earnings growth and concurrent inflation that capital markets are now baking into asset prices.
Today we offer up a snapshot of “BT” expectations for corporate fundamentals in the form of pre-election analysts’ estimates for future revenues and earnings. From the high flying Dow Jones Industrial Average, we find that analysts were already looking for average revenue growth of 4.5% for 2017 “Before Trump”, but little expansion in Q4 (just 1.6%). As for the S&P 500, pre-election estimates from FactSet show expected revenue/earnings growth of 5.5%/11.4%. Importantly, Industrials, Financials and Materials (3 winning sectors post-election) all showed lower expected revenue growth than the index on average.
We’ll be looking for earnings revisions to support the recent moves; at least earnings expectations were low enough that incremental revenues will, in fact, help support upward revisions.
“I know where you live. I know where you work. You’re going to get what’s coming to you. You’re going to die. I promise.”
If you worked as a sell side analyst in the 1990s, you probably heard a similar message on your work voicemail at some point (and probably more than once). I covered the auto stocks back then, and many workers in that industry felt Wall Street was forcing management to close U.S. factories in order to satisfy our financial expectations. As one analyst that got quoted in their local papers, they figured it was partially my fault. The fear they hoped their message would elicit (and it certainly did) was payback for the fear they felt over losing their jobs. Fair enough – I never took these calls personally.
It wasn’t just me – tech sector analysts got their share of public ill-will during and after the tech bubble in the 1990s. Downgrade a favorite high flier while markets were stilling rising? Or stay on the bus too long after the bubble began to burst? You were pretty sure to walk into the office and have your share of 2am voicemails forecasting your impending demise.
I haven’t heard such stories from friends in the business in many years, however, probably for the simple reason that sell-side analysts don’t really have the public profile they used to enjoy. Higher sector correlations to the market and the trend to passive investing have limited their impact on market psychology. In their place, Fed-watching macro analysts have taken their turn in the spotlight.
Equity market price action since the U.S. election last week shows the fortunes of the single-stock analyst may be about to change. Over the last 5 days, Large cap Industrial stocks are up 8.6%, Health care equities are +5.7% and Financials are 14% higher. The S&P 500 is only up 3.8% over the same timeframe. Investors are trying to pick winners and losers again – an interest we haven’t seen in a long time.
Stocks always move ahead of actual changes in their fundamentals, so these gains are simply the market’s best guess about the future earnings impact of a Trump presidency. Changes in corporate and personal tax rates, infrastructure investment, alterations to the regulatory structures around Financial Services and Health Care… At this point markets are enjoying the anticipatory sizzle of the steak that is making its way to our table.
To get a sense of just how much upside these sectors – and other presumed winners in a Trump presidency might enjoy – we first need to look backward to the last pre-election expectations for corporate fundamentals. A few points here:
All this comes down to one word: leverage. Not financial leverage, though… Operating leverage.
Prior to the election, investors didn’t believe there was much operating leverage available in corporate America. Slow revenue growth, slow inflation, slow wage growth, slow earnings growth. That was the recipe for next year.
Now, expectations for better economic growth have markets scrambling to find companies with the operating leverage (read high fixed costs and high incremental margins) to show outsized earnings growth as a result. It isn’t just that infrastructure spending will help Industrial companies; the magic here is that prior to the election no one expected much from this sector, and their high fixed costs meant that was a rational to be wary of any real upside. Post-election, cyclical exposure and high contribution margins are a feature, not a bug.
Now, it is up to analysts and investors to parse out the future and determine if markets have run too far with this theme, or not far enough. All we know is that U.S. stock prices expect more growth than they did a week ago. And the more they rise, the more they expect.