Earnings: The real Trump bump

Analysts’ profits forecasts have edged modestly higher in the first month of the year in continental Europe and the UK, as would be expected during a period of above-consensus global economic data. In the US however, tax reform has added to the cyclical economic strength, pushing median 2018 profits forecasts dramatically higher, up 4% over the past month alone. This represents 2/3rds of our total expected benefit to US earnings from tax reform. Earnings revisions data supports our strategic view of strong momentum carrying over into Q1/Q2 2018. However we also note that economic surprise indices may have peaked in January and combined with forecast rate increases, markets may yet tread water as the year progresses.

Exhibit 1: Unweighted earnings revision index for US, Europe ex-UK and UK

As Exhibit 1 shows, after declining somewhat in Q3 17, unweighted EPS forecast trends for 2018 have been supported by positive economic momentum and in particular from rising forecasts in the commodity and energy sectors. The outlier is the US where estimates have risen by 4% over the past month which reflects the impact of tax reform. This is already 2/3rds of the total positive impact that we expected.

Exhibit 2: Unweighted consensus earnings growth forecasts

Median consensus earnings growth is now 8% in the UK, 10% for continental Europe and 13% for the US, where the impact of US tax reform is again clear. We believe investors should note that estimates tend to fall over the year (absent continued positive economic surprise, evident in 2017) and start-of-year forecasts in some respects represent “default” levels.

Exhibit 3: Global economic surprise – has it peaked?

In respect of the economic surprise indices, we note a very modest easing during January, Exhibit 3. The key to market performance over the full year will in our view be the extent of the lagged effect of monetary tightening of 2017 on the economy and bond yields during 2018. While there is no reason for panic in respect of the real economy at the present time, equity valuations remain stretched in our view and a period of consolidation to allow earnings to catch up with high market multiples cannot be excluded.