Prophets

Bull Market in Stocks Is Justified by Earnings

Third-quarter profits and revenues rose faster than expected, and the economy is performing better than forecast.

More than 500,000 vehicles may have to be replaced.

Photographer: Thomas B. Shea/AFP/Getty Images

We’re still in the heart of earnings season, with more than 40 percent of the S&P 500 companies accounted for.

A few observations are already noteworthy. Most importantly, third-quarter corporate profits and revenues rose faster than expected and additional information is unlikely to change this trend. Also, the economy more broadly is performing better than forecast. Gross domestic product increased 3 percent in the quarter, a very solid number considering that hurricanes disrupted growth during the period. The momentum behind the data suggests a positive near-term outlook for U.S. companies and the economy. Although stock prices have done quite well recently, there’s every reason to expect more gains in the months ahead, as well as more weakness in the bond market.

By one count, earnings-per-share beats are as much as four times greater than EPS misses, a notably large difference. Also, sales have also been running at least three times faster than misses in revenues. These are very solid gains. Moreover, three of the largest companies -- Amazon, Alphabet and Exxon Mobil -- handily topped estimates of profits and sales. Nonetheless, these strong performances make sense when GDP has outperformed expectations.

The hurricanes that hit Texas and Florida were thought to have reduced growth by somewhere between 0.5 percent and 1 percent at an annual rate for the third quarter. If that estimate is correct, it suggests the economy was motoring along quite nicely before the storms. Indeed, the third-quarter gain followed a 3.1 percent expansion in the second quarter. And any reduction in growth caused by the storms will boost fourth-quarter activity, as the damage is repaired and the lost items are replaced.

This is most obviously the case for autos. Hurricanes Irma and Harvey are thought to have destroyed more than 500,000 vehicles. Indeed, auto sales have increased from a 16.5 million annual selling rate in August to an 18.9 million rate in September, a surge that replaces about one-third of the cars lost so far. So, sales in October should also be fairly robust, even if they come off the high September level. 

What does all this mean for markets? The very robust stock performance of recent weeks, along with the weakness in bonds, is the correct response for markets and in accordance with our expectations. We remain positive (though not euphoric) on stocks and expect a pounding for bond prices.

Looking ahead, stronger growth promises to maintain the fairly rapid pace of decline in the unemployment rate, rendering labor scarcer and reinforcing upward pressure on worker costs. This will present some policy issues for the next Fed chairman. Moreover, nothing on the horizon threatens to undermine these trends. All of this is positive for projections of corporate profits and damaging to bond prices. Passage of the first budget bill that could potentially lead to tax reform, lower rates for households and business, and a larger budget deficit only strengthens these forces already in place. Even so, the market will not believe it or price it into markets until the fiscal program is much closer to final approval. Thus, the positive performance of stocks and the negative performance of bonds does not yet reflect the possibility of tax reform, since that remains only a possibility at this stage. Markets are reflecting what they see occurring, which is solid GDP growth and profits. Readers should expect more of the same.

Bloomberg Prophets Professionals offering actionable insights on markets, the economy and monetary policy. Contributors may have a stake in the areas they write about.

    To contact the author of this story:
    Charles Lieberman at chuck@advisorscenter.com

    To contact the editor responsible for this story:
    Max Berley at mberley@bloomberg.net

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