You’ve Got to Earn It: Valuations Aided by Improving "E"

Key Points

  • Economic (and earnings) momentum has picked up—and not just post-election.
  • Earnings are expected to grow by more than 12% in 2017.
  • Valuations are reasonable considering inflation; but that also represents a risk factor next year.

The stock market has had an excited run since the presidential election, with heightened optimism for growth looking ahead into 2017. Not to rain on the optimists’ parade, but there was actually ample evidence of improving growth before the election.

Economy better than expectations

As seen in the chart below, the recent surge in the Citigroup Economic Surprise Index—a measure of how economic reports are coming in relative to expectations—began about three weeks ahead of the election.

U.S. Citigroup Economic Surprise Index

Source: FactSet, as of December 2, 2016.

Notable strength has been seen among the various confidence measures—including consumer and business—regional manufacturing indexes, both ISM manufacturing and services indexes, housing-related data, the oil/gas rig count, railcar loadings, retail sales, motor vehicle sales, and job/wage growth.

Earnings recession decisively over

The improvement in economic growth and prospects has helped turn the earnings expectations frown upside down. The table below shows earnings growth by sector (and for the S&P 500 overall), covering each quarter so far this year, as well as for 2017. The first two quarters of 2016 now represent “actual” results; while the third quarter is not yet official (hence, they’re still “expected” results). Clearly, since they haven’t yet been reported, the data shown for both the fourth
quarter and next year are “expected” results.

Estimated earnings growth table

Source: Thomson Reuters, as of December 2, 2016.

Nowhere is the improvement in earnings more dramatic than in the energy sector. From a drag of more than -100%, energy sector earnings are expected to rebound by nearly 350% in 2017. But it’s not just energy—every one of the 11 S&P 500 sectors is now expected to show positive growth next year.

After three consecutive years (2014, 2015 and 2016) of S&P 500 earnings of about $118—i.e., no growth—Thomson Reuters has nearly $133 as an expectation for 2017.