Should we be concerned about “peak earnings growth”?
Author: Jonathan Lo
May 9, 2018
A more volatile environment in 2018 has resulted in a “standoff” between bulls and bears, with the markets having recently traded in an increasingly tight range. If you believe the chart, we’re approaching a critical moment where this may be resolved either to the upside or downside.
Source: Bloomberg
Bears might increasingly point to “peak earnings growth” on the market as a reason to get cautious. Indeed, we have noticed several notes on the topic of peak earnings growth recently – with earnings growing at a 20%+ year-over-year rate, sell-side estimates from the current earnings season imply that S&P 500 EPS growth would hit a peak in the second half of this year.
We would point out, though, that peak earnings growth has seldom resulted in the end of a bull market. In fact, since the 1950’s, S&P 500 performance has been at approximate average levels (8.1%) in the year following earnings growth peaks, and returns were positive nearly 70% of the time.
S&P 500 Trailing One-Year EPS Growth Peaks and Subsequent Performance
| S&P 500 Subsequent Holding Period Performance | |||||
|---|---|---|---|---|---|
| Peak EPS Growth Date | Peak EPS Growth Rate | 3 Months | 6 Months | 12 Months | Recession? |
| 2/29/1956 | 34.8% | 0.3% | 4.8% | -4.6% | No |
| 3/31/1960 | 20.8% | 2.9% | -3.3% | 17.6% | Yes |
| 7/31/1962 | 24.3% | -2.9% | 13.7% | 18.7% | No |
| 10/31/1965 | 16.9% | 0.5% | -1.5% | -13.2% | No |
| 10/31/1968 | 10.3% | -0.4% | 0.3% | -6.0% | No |
| 2/28/1974 | 31.3% | -9.3% | -25.0% | -15.2% | Yes |
| 12/31/1976 | 26.5% | -8.4% | -6.5% | -11.5% | No |
| 10/31/1979 | 32.5% | 12.1% | 4.4% | 25.2% | Yes |
| 8/31/1982 | 18.7% | 15.9% | 23.9% | 37.6% | No |
| 1/31/1985 | 33.5% | 0.1% | 6.3% | 17.9% | No |
| 9/30/1988 | 52.3% | 2.1% | 8.4% | 28.4% | No |
| 5/31/1993 | 23.4% | 3.0% | 2.6% | 1.4% | No |
| 4/30/1995 | 46.2% | 9.2% | 13.0% | 27.1% | No |
| 11/30/1997 | 15.7% | 9.8% | 14.2% | 21.8% | No |
| 8/31/2000 | 16.4% | -13.4% | -18.3% | -25.3% | Yes |
| 7/31/2004 | 26.0% | 2.6% | 7.2% | 12.0% | No |
| 9/30/2006 | 17.8% | 6.2% | 6.4% | 14.3% | No |
| 11/30/2010 | 71.0% | 12.4% | 13.9% | 5.6% | No |
| 10/31/2014 | 9.1% | -1.1% | 3.3% | 3.0% | No |
| Average | 27.8% | 2.2% | 3.6% | 8.1% | |
| Positive % | 63.2% | 73.7% | 68.4% | ||
| Non-recession Average | 25.5% | 3.2% | 7.3% | 10.2% | |
| Non-recession Positive % | 66.7% | 86.7% | 73.3% | ||
Source: BMO Capital Markets, as of May 2018
Although consensus estimates indicate earnings growth may peak around the fourth quarter of this year, the market is expected to continue to deliver double-digit earnings growth for the forseeable future. Moreover, the recent robust earnings growth has meant the forward multiple on the S&P 500 has come back to more attractive levels – on calendar year 2019 EPS estimates, the S&P 500 is now trading at 15.4x.
Finally, it is also important to acknowledge that the boost in earnings growth this year has been in part attributable to U.S. tax reform and the corresponding lowering of the corporate tax rate. As that is a one-time event, basing effects inevitably mean that subsequent periods will likely see lower earnings growth. However, top line growth (currently at 8.5% for the S&P 500) remains robust and indicative of the continuation of a strong economic environment for corporations.
Source: Stretegas Research, April 2018
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