The first quarter earnings reporting period has been strong -- not just stronger than expected, but actually strong.
According to FactSet, the blended first quarter earnings growth rate for the S&P 500 is 13.9%. That qualifies as the strongest growth rate since the third quarter of 2011 and it is well above the 8.9% growth rate projected when we published our earnings preview on April 7.
That is something to cheer about, but remarkably, the stock market hasn't really been moved by the encouraging earnings results. It has been supported by them, but it hasn't been moved by them.
What the stock market has been moved by is politics, just as we thought it would be when we published our earnings preview.
To clarify our position, we'll be taking a retrospective look at the first quarter reporting period and the stock market's behavior throughout it. This look back is an important exercise because it may just provide a glimpse of what lays ahead.
The French Connection
This stock market is gripped by politics right now and the tax reform process specifically. Because it is, expect the spin on the first quarter reporting period to be spun more by the political narrative and less by the earnings themselves.
That was the concluding line from our first quarter earnings preview. The S&P 500 closed at 2355.54 on the day we published that report. This past Wednesday, May 17, it closed at 2357.03.
It was a bit of a winding political road in terms of how the S&P 500 got to nowhere.
The leading investment banks raced out of the gate with better-than-expected earnings results, Goldman Sachs (GS) excluded. JPMorgan Chase (JPM) started things off on April 13, but on April 21, the S&P 500 closed at 2348.69.
So, there was really good earnings news for the most part out of the financial sector, and yet the S&P 500 declined 0.3% between April 7 and April 21.
The halting consideration for the stock market at that time was the French presidential election. There was some significant concern that the first round of the election might go in favor of two anti-EU candidates. The fate of the European Union, then, was in question and market participants saw that as a risk with a potentially very fat tail.
As it turned out, centrist candidate Emmanuel Macron and anti-EU candidate Marine Le Pen took the top two spots in the initial round of balloting on April 23. The market breathed a sigh of relief upon knowing that since it was widely believed that Monsieur Macron would defeat Madame Le Pen in the second, and final, round of balloting on May 7. The market was right.
That relief was clear to see on April 24 when the S&P 500 increased approximately 26 points, or 1.1%, to 2374.15.
A major political hurdle was cleared, as Macron's victory took the worst-case scenario of France leaving the EU off the table. At the same time, it left the stock market an opening to concentrate on the plethora of better than expected earnings reports.
With the French election risk abated, the Trump Administration released the core principles of its tax reform plan on April 26 and then the House GOP figured out a way to reach a compromise on its health care reform bill, eventually passing the measure (217-213) on May 4 and clearing a path for the bill to move to the Senate for consideration.
There were many reservations about the tax reform plan, namely its lack of details, and the viability of the House GOP's health care bill in the Senate. Still, the stock market appreciated that the walk down the path to tax reform had at least begun.
The S&P 500 would rise as high as 2405.77 by May 16, leaving it up 2.1% from its close on April 7 and at a new record high.
That was a nice gain and it certainly registers well when annualized, yet it's hard not to see it as a bit underwhelming given the strength of the earnings results. Per FactSet data:
- Every sector saw a pretty sizable upward revision to the first quarter earnings growth estimates seen on March 31, with the exception of the telecom services sector.
- 75% of the S&P 500 companies reporting their results through May 19 exceeded consensus earnings estimates, which is above the 5-year average of 68%
- The blended sales growth rate for Q1 is 7.7%, which is the highest revenue growth since Q4 2011
That was all good and it was certainly supportive, yet the real driver of the stock market was made crystal clear on May 17 when the S&P 500 dropped approximately 44 points, or 1.8%, following a New York Times article that had political and market pundits abuzz with talk of President Trump being at risk of facing impeachment proceedings.
Briefly, the article cited a memo by former FBI Director Comey, which reportedly said the president told Mr. Comey on February 14 that he hoped the FBI could let go of its investigation of former National Security Adviser, Michael Flynn.
The interpretation in some circles is that such a statement by the president is tantamount to an obstruction of justice, which is an impeachable offense.
The takeaway for the stock market at first blush, though, is that an investigation into the matter will be a distraction that delays the implementation of the administration's growth initiatives, which revolve around tax reform, deregulation, and infrastructure spending, or perhaps prevents them from coming to fruition at all.
The House Oversight Committee has a hearing scheduled for Wednesday, May 24, to investigate the Comey-Trump matter further.
A Patented Claim
It would be remiss not to add that the S&P 500 managed to bounce back noticeably from the May 17 political drubbing. The supposition is that it was able to do so for a few reasons:
- It was thought that the impeachment talk was overblown; and
- There was a consideration that, if President Trump was impeached, Vice President Pence would still be pushing through the same growth agenda as president, but in a more pragmatic manner
In other words, it was political considerations once again driving the market, with rising oil prices, an encouraging earnings report from Deere & Co. (DE), and the patented buy-the-dip trade riding shotgun.
Arguably, the latter would not have happened if the market didn't find a basis to temper its political concerns. To that end, remember that the market didn't find a basis to advance on the good earnings results in the early part of the reporting period until its concerns about the French election were tempered.
What It All Means
The goings-on in Washington of late reinforce the thrust of our Market View update from March 17 in which we said the post-election honeymoon phase with the Trump Administration was ending, meaning the potential for marital discord and downside risk was rising.
There hasn't been much downside admittedly since March 17 when the S&P 500 closed at 2378.25. Then again, there hasn't been much upside either. The S&P 500 is trading at 2386.21 as we write this.
That's remarkable given the strength of the first quarter earnings reports, yet it is indicative of a market that is being driven right now more by politics than it is by earnings.
The two in a certain respect go hand-in-hand, because lofty earnings expectations embedded in stretched P/E multiples are a byproduct of the belief that political progress will be achieved and that there will be actual legislation producing lower tax rates, less regulation, and increased infrastructure spending.
That proposition isn't being taken for granted, which is why all the strong first quarter earnings reporting period can do is support the market and not drive it.
If the political uncertainty clears up with the passage of the pro-growth initiatives the stock market favors, then strong earnings results may shine through again as a market driver.
Unfortunately, the skies over Washington remain thick with grey clouds, and as long as that is the case, indecision may continue to rain down on Wall Street and hold the market in check despite the positive spin that can be put on the earnings outlook.