Strong earnings season expected for S&P 500 companies with tax reform a likely contributor.
With first quarter earnings season set to kick off in the coming weeks, investors may get more insight into how companies plan to use savings from December’s tax reform. And any announcements of more share buybacks and dividend increases could be welcome news for the broader U.S. stock market as tracked by the S&P 500 index – a benchmark that just experienced a quarterly loss for the first time since 2015.
For the three months ended in March, the S&P 500 fell by 1.22%. Only two of the index’s 11 sectors finished the quarter with gains – information technology (IT), which was up by 3.2%, and consumer discretionary, which gained by more than 2.7%. Those two sectors managed to eke out gains despite the broad technology sell off in recent weeks (Facebook, Google Alphabet-C and Alphabet-A, Apple and Microsoft are among the main constituents in the IT industry sector, while Amazon is a big component within consumer discretionary).
The recent volatility in global equity markets, which began in late January and early February, and continued in March with fears over a potential trade war and concerns over heightened scrutiny in the technology space, has presented challenges as to whether the long running bull market in the U.S. can continue. Earnings season could be the tonic to, at least, provide some near-term support.
“We haven’t been getting that real key fundamental data the markets key on and has been sustaining this rally since the middle of 2016 which is improving corporate earnings,” Brian Nick, chief investment strategist at Nuveen, told CNBC’s “Futures Now” in late March.
First quarter earnings for companies within the S&P 500 are expected to grow by 17.3% year-over-year, according to FactSet. Analysts also upwardly revised the current estimates by 5.4% during the quarter. That marked the largest increase in the earnings-per-share (EPS) estimate since FactSet began tracking it back in the second quarter of 2002.
A significant factor in the upward revisions is the decrease in the corporate tax rate due to the new tax law, FactSet said, though it’s difficult to quantify the exact impact.
Other factors like rising oil prices have likely contributed to upward revisions for the energy sector, while expectations in 2018 for higher interest rates (which benefit banks’ lending margins) have also likely contributed to the significant increase in earnings estimates for financial companies, FactSet said.
Investment, Dividends and Share Buybacks
So what are S&P 500 companies likely to do with any windfall associated with the tax cut? An analysis by Hamilton Place Strategies (HPS), an analytical public affairs consulting firm, found that 419 companies explicitly mentioned tax reform in their fourth-quarter earnings calls.
According to the analysis:
- 179 earnings calls mentioned investment in response to tax reform – meaning reinvesting directly back into the company or its employees, such as capital expenditures, research & development, bonuses, or wage increases;
- 131 calls discussed returns to shareholders through stock repurchases or dividends;
- 42 talked about mergers & acquisitions;
- 31 discussed charitable giving – meaning donations to foundations or community organizations; and
- 29 talked about paying down debt.
Most mentions of investment related to tax reform – 157 calls – related to capital expenditures, with another 55 mentioning employee bonuses and wage increases, and another 50 references to other employee benefits. There were only five mentions of hiring.
Of the 131 earnings calls that mentioned total returns to shareholders, 50 mentioned both buybacks and dividends, 33 only discussed dividends and 18 calls mentioned plans to only buy back shares. On another 30 calls, companies made general mentions of returning a tax reform windfall to shareholders without specifying how, according to HPS.
Nuveen’s Brian Nick told CNBC that more share buybacks and higher dividends would give markets a short-term “pop,” but not the longer-term push needed to grow companies and U.S. economic activity.
“It would be a short-term positive for the market if you saw a lot of buybacks and higher dividends. But I think that would probably also lead us to be less optimistic about just how long the cycle can go on,” he told CNBC.
Beyond total returns to shareholders, the earnings story could be the focus for whether the bull market regains steam and continues its run during the second quarter, or falters.
For their part, earnings estimates tend to lag macroeconomic events, such as tariffs. Trade actions take time to affect goods moving across borders, according to LPL Financial. Yet earnings estimates haven’t been lowered in response to the recently announced tariffs, which LPL interprets to mean that earnings fundamentals remain solid.
“With economic growth improving, manufacturing activity humming, and analysts’ estimates having soared this year, we expect strong mid-teens earnings gains for the S&P 500 in 2018,” LPL Financial said in research published March 26.
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