FM Wealth Management News Letter
We are now coming up to earnings season, so we are warning you now that
the numbers may not live up to the S&P 500 (SPY) rally we have seen
during the last little while.
The reason for that is that the rally has been pricing in the flow-through of benefits of the new tax reforms, and these benefits won’t yet be seen in fourth quarter earnings from 2017.
In fact, it is expected that EPS will decline from a 3Q17 by 0.3% as charges related to income tax are expected to be booked.
This of course does not mean that the rally is not justified we can just call it premature or anticipatory. In the chart below Morgan Stanley (MS) illustrates how EPS estimates have increased for 2018 after the tax bill was passed on 15th December. You should note that 4Q17 figures only show a tiny gain.
These are only estimates based on guidance and we cannot be 100% sure that these estimates will be met, or how much the tax bill may contribute, but the equity rally since mid December was largely due to the expectation of these increases.
EPS increases obviously increase the P/E ratio, which then starts to cause concerns about valuations.
The S&P 500 P/E ratio moved above 25 in December for the first time since the beginning of the bull market in 2009 in fact with the gains we saw over the last two weeks, it now stands at 26.16.
This high P/E number is unlikely to come down significantly as it adjusts to fourth quarter numbers.
Full year EPS estimates are for $110.57 (based on GAAP), which at the current S&P 500 closing prices of 2802.56 means a P/E ratio of 25.34. This will make some investors uncomfortable over the next few months.
At the very least it won’t encourage further multiple expansion. This may make the rally may stall for a while until the market has a better idea of 1Q18 numbers.
This was a point made by Morgan Stanley in their note on earnings.
The reason for that is that the rally has been pricing in the flow-through of benefits of the new tax reforms, and these benefits won’t yet be seen in fourth quarter earnings from 2017.
In fact, it is expected that EPS will decline from a 3Q17 by 0.3% as charges related to income tax are expected to be booked.
This of course does not mean that the rally is not justified we can just call it premature or anticipatory. In the chart below Morgan Stanley (MS) illustrates how EPS estimates have increased for 2018 after the tax bill was passed on 15th December. You should note that 4Q17 figures only show a tiny gain.
These are only estimates based on guidance and we cannot be 100% sure that these estimates will be met, or how much the tax bill may contribute, but the equity rally since mid December was largely due to the expectation of these increases.
EPS increases obviously increase the P/E ratio, which then starts to cause concerns about valuations.
The S&P 500 P/E ratio moved above 25 in December for the first time since the beginning of the bull market in 2009 in fact with the gains we saw over the last two weeks, it now stands at 26.16.
This high P/E number is unlikely to come down significantly as it adjusts to fourth quarter numbers.
Full year EPS estimates are for $110.57 (based on GAAP), which at the current S&P 500 closing prices of 2802.56 means a P/E ratio of 25.34. This will make some investors uncomfortable over the next few months.
At the very least it won’t encourage further multiple expansion. This may make the rally may stall for a while until the market has a better idea of 1Q18 numbers.
This was a point made by Morgan Stanley in their note on earnings.
No comments:
Post a Comment