Q1/2018: How Earnings Season Could Make or Break Stocks

Q1 2018 earnings season is underway, and in my view it could be the most important driver of stock prices in the near-term. More so than the bubbling trade dispute, growing fears of technology regulation, or any other fear circulating the markets today.

Why would I be worried about an earnings season where expected earnings growth is a robust +17.1%? That's just it -- the expectations may be too robust, setting a hurdle too high for Corporate America to clear. And there's nothing the market dislikes more than growth or earnings coming up short of expectations. Indeed, one of the worst outcomes on Wall Street is when estimates are revised down and corporations fall short. That’s why S&P 500 companies usually make it a point to try and under-promise and over-deliver. 

Yet, Earnings are Being Actively Revised Higher

On December 31, 2017, the estimated earnings growth rate for the first quarter 2018 stood at +11.4%. As of this writing, the estimate has climbed to +17.1%. The quick take on this meaningful increase is that corporations have adjusted for the impact of tax cuts, and CEOs also appear to be more optimistic about the economy—even as the threat of tariffs loom.

All eleven S&P 500 sectors are expected to report year-over-year earnings growth in Q1, with seven of those sectors expecting to see double-digit earnings growth led by Energy, Materials, Information Technology, and Financials. If +17.1% ends up being the actual earnings growth rate for the quarter, it would mark the highest quarterly earnings growth in seven years.

Analysts have also revised their full-year earnings growth forecasts, now expecting full year earnings growth of +18.5% and revenue growth of 6.7%.

Again, higher earnings that are significantly stronger than years' past is a good thing ultimately. It means the economy is healthy and companies are growing. But it could also be argued that stocks have already priced-in this growth and earnings, such that current prices already reflect these robust growth rates. That's why I think if corporations fall short, stocks could fall in the near term. Earnings need to beat estimates by more than usual to push equities higher, but I fear the bar is currently set too high for them to do so.

Watch Earnings Season Closely

My advice to investors would be to watch earnings season closely, and to hope that companies somehow manage to exceed already high expectations. It will be a tall order. 

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