Investors are being inundated with political headlines but they would be best served to ignore the political noise and focus on market fundamentals. As we have discussed previously, and shown in the chart below, stock prices have a high correlation to corporate earnings. Get the direction of earnings right and typically you will get the direction of the stock market right over the long term. Certainly short term external shocks can disrupt the trend but over the long term, earnings have been shown to drive stock prices.
We are in the middle of Q4 earnings season and we are getting a good picture of earnings with 55% of the S&P 500 reporting as of last Friday. Thus far the results have been fair with 65% of companies that have reported beating estimates, which is close to but lower than the 5 year average of 67%.
More important is what the earnings prospects look like for 2017. Analysts are typically aggressive every year in their earnings growth estimates for the equity market. Analysts usually start earnings estimates too high then have to ratchet down estimates as the year progresses. Thus far, however, earnings estimates have remained stable. According to Factset, earnings for 2017 are expected to grow at over 11% from 2016 – right in line with where the estimates were 3 months ago. Estimates for 2018 are rising from three months ago and are nearing 12% growth. A recovery in the energy sector and a better interest rate environment for financials should help earnings growth this year and next. A growing earnings backdrop is a core reason we remain constructive on equity markets relative to fixed income and remain overweight equities in our fundamental portfolios.
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