John Lynch Chief Investment Strategist, LPL Financial
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Fourth quarter earnings season has been outstanding. As good as it has been, perhaps most impressive is the strong guidance corporate America has provided. In response, we have raised our S&P 500 Index earnings forecast for 2018 and our S&P 500 year-end fair value target proportionately. Our revised year-end S&P 500 fair value range of 2950–3000, approximately 7–9% above Friday’s close, represents a 19.5 price-to-earnings (PE) ratio on $152.50 in earnings per share (EPS).
Strong Company Guidance
Fourth quarter earnings growth of over 15% reported by S&P 500 companies is outstanding, in our opinion, but the lead headline is the strong corporate guidance. That positive message has translated into a more than 7% increase in consensus S&P 500 operating earnings estimates for 2018 [Figure 1]. A ramp that swift and sharp, in an already favorable earnings environment, is unprecedented in our experience.
Most of that 7%-plus increase was driven by the new tax law, which we highlighted here in December 2017, noting it would favorably impact U.S. corporations due to a reduced tax burden, provision for immediate expensing, and repatriation of foreign-sourced profits. Given that estimates have historically dropped by an average of approximately 3% during earnings season, the recent 7% positive revision seems more like a 10% increase in potential corporate earnings growth. Of those three percentage points, perhaps one is a weak U.S. dollar, but that still leaves two percentage points of upside possibly driven by the favorable macroeconomic and business climate. Companies are optimistic, which is evident in business confidence surveys. This optimism traditionally translates into improved business investment.
The breadth of optimism seems apparent when tallying the number of S&P 500 companies that have raised annual guidance during fourth quarter earnings season and comparing those numbers over time. As shown in Figure 2, the number of companies raising guidance for this year is double the highest levels of the past decade for the same period.
Updating Our 2018 Earnings Forecast
In response to such a strong outlook from corporate America, we are raising our 2018 S&P 500 EPS target by $5 to $152.50, reflecting 15% expected earnings growth, up from our prior forecast of $147.50, or a 12% increase. We expect earnings to continue to get strong support from accelerating U.S. and global economic growth, a pickup in business spending, and strong manufacturing activity. We believe increasing costs, particularly wages, will only be a modest drag on profit margins. Share repurchases from overseas profits repatriated back to the United States may also provide an additional boost.
We want to emphasize that despite our optimism, our revised forecast for S&P 500 EPS remains below consensus, which currently hovers around $157.50 per share for 2018. We are comfortable with our forecast for several reasons: