With S&P 500 valuations now close to fair, CIO expects upside in markets to be driven by earnings growth. (ddp)


In aggregate, earnings are beating by 3.5%, which is consistent with historical averages. CIO's outlook for 0–2% EPS growth this quarter remains on track, with growth for the median company about 2% better than this.


Even more encouragingly, guidance also appears to be favorable. On average, analysts have largely kept their 2Q19 estimates unchanged (down 0.1% for the median company) for the 77 companies that have reported first-quarter results. This is a notable improvement from last quarter when profit estimates for the next quarter fell by 2.2%.


Profit margins are coming in better than expected. While wage pressures continue to rise, S&P 500 companies have many levers to pull to protect margins: higher productivity, outsourcing, price increases. CIO expects the most intense wage pressures to be in the consumer discretionary sector (retail, restaurants, hotels) which are also some of the most labor-intensive businesses. But for the S&P 500 in aggregate, we expect profit margins to remain well-supported. In prior late cycle periods—when wages were rising at an even faster rate—profit margins did not fall on a sustained basis.


CIO continues to expect earnings growth to be somewhat flattish in the first half of the year, but it should accelerate to a mid-single-digit rate in the second half and into 2020 as global economic growth improves and headwinds in commodities and tech begin to fade. CIO's S&P 500 EPS estimates of USD 168 (+3%) for this year and USD 179 (+7%) for next year remain unchanged.


By sector and end-market, results have come in largely as expected. Within financials, consumer businesses have been solid, but anything related to capital markets activity has been weak (which was expected). Importantly, credit quality remains very healthy, which shouldn't be too surprising given how strong the labor market is.


Perhaps the biggest surprise has been the strong organic growth in the handful of industrial companies that have reported. For instance, Honeywell's organic revenue growth of 8% accelerated from last quarter and was the highest since 2011. Strong trends in aerospace, underpinned by solid global travel trends, have been a key driver.


With S&P 500 valuations now close to fair, CIO expects upside in markets to be driven by earnings growth. CIO's rolling six-month price target for the S&P 500 is 2,950.


Original blog: E arnings season week 1: pretty good, 18 Apr. 2019.


Main contributors: David Lefkowitz, CFA Sr. Equity Strategist Americas; Edmund Tran, CFA, Equity Strategist Americas


Content is a product of the Chief Investment Office (CIO).