The season for the release of quarterly financial reports is upon us. Throughout the month, financial reports for the third quarter (Q3/2016) for the American corporate sector will be published, and stock prices will be most influenced by the earnings of large corporations. Additional volatility and uncertainty in the market will be felt as the presidential elections in the U.S. approach. The S&P 500 index is just 1.6% away from its historical peak reached in August, and the valuation of the stock market is quite high, above historical averages, which creates pressure for further index growth. Corporate sector earnings have been declining for several consecutive quarters, and it can be said that corporate earnings in the U.S. are in some kind of long-term recession. The increase in earnings through stock buybacks (buy back program) only superficially boosts company earnings, as total profit is divided among a smaller number of shares, leading to higher earnings per share. Everything seems excellent at first glance, but this is not a sustainable model in the long run. Let’s take a look at the status of the most well-known global stock index, the S&P 500.
The current valuation of the S&P 500 index is quite high. The dividend yield is 2.04%, which is not terribly low, while the future price-to-earnings (P/E) ratio is high at 17, and the historical average is around 15. The price-to-earnings ratio simply tells us how many years it would take to recoup the investment if the price and earnings remained at the same level. Although there is considerable controversy over which level is undervalued/overvalued, the indicator has its value and more advantages than disadvantages. According to Thomson Reuters data, analysts expect a 0.7% decline in earnings in the third quarter compared to the previous year. However, the decline will likely be somewhat smaller or even positive, as analysts’ expectations are set quite low, and a larger number of companies exceed expectations. From the beginning to the end of the quarterly results announcements, earnings forecasts for the S&P 500 have been around 3.4% since 2002. If this statistical data proves accurate, then a 2.7% increase in earnings can be expected, which could stimulate stock price growth. A 2.5% increase in company revenues is also likely, marking the first annual growth since 2014. The continued rise in energy prices will certainly positively impact the revenues and profits of companies in the energy sector.
