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US earnings might deflate lofty valuations

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Investors are gearing up for US earnings to kick off this week, though some are sceptical that boosts in earnings growth – particularly in the tech sector – will continue to support the lofty valuations that have driven US stocks to record highs.

Financial stocks begin the season, with JPMorgan Chase, Citigroup and Wells Fargo due to report on Friday, though all eyes will be on the “FAANG” stocks – Facebook, Apple, Amazon, Netflix and Google – which report next week. 

Investor attention will turn to the so-called "FAANG" stocks – Facebook, Apple, Amazon, Netflix and Google – which ... Investor attention will turn to the so-called “FAANG” stocks – Facebook, Apple, Amazon, Netflix and Google – which report next week.  Photo: Bloomberg

According to figures compiled by Factset, a data intelligence firm, the estimated earnings growth rate for the S&P 500 is 6.6 per cent, with the technology sector set to report 10.5 per cent earnings growth; the second highest of all 11 sectors, with financials set to report 6 per cent. 

These two sectors contributed a 14 per cent year-over-year jump in earnings per share in the first quarter, and combined, the two sectors outstripped the performance of the S&P 500 over the second quarter, rising 3.8 per cent while the broader index lifted 2.6 per cent. 

But this performance is a considerable slowdown from the 5.5 per cent rise the S&P 500 managed during the first quarter of 2017, when investors were still riding the pro-growth euphoria that followed Donald Trump’s election win in November. 

Pro-growth optimism already priced into market

UBS analysts have suggested there is unlikely to be much of a share price uptick this time around given much of this optimism is already priced into the market. 

“Earnings ‘beats’ alone may not be sufficient to drive further upside as financials where sentiment may be running ahead of fundamentals, tries to assume leadership from technology, where rising 10-year yields continue to exert pressure on the higher multiple names,” UBS analysts said in a note to clients. 

The forward 12-month P/E ratio for the S&P 500 is 17.3, which is above the five-year average of 15.3 and the 10-year average of 14.0.

Analysts argue there is already a steady rotation out of technology stocks under way, with investors instead preferring financials as interest rates and bond yields rise. 

Tech stocks have slumped 4 per cent since the first week of June, while financials have climbed more than 5 per cent and healthcare is enjoying a 3 per cent lift. 

“It is possible technology stocks report a positive earnings growth print, though this may not be ultimately reflected in the share price,” said UBS.

Nine sectors are expected to report year-on-year earnings growth, with energy stocks outstripping the rest of the market, thanks to a miserable performance last year. 

Semi-conductor companies are doing most of the heavy lifting within the technology sector.

“High trailing P/Es don’t really scare us when it comes to these US technology companies,” said Timothy Samway, managing director of Hyperion Asset Management, which has large positions in Facebook, Amazon and Alphabet, parent company of Google. 

“Based on short-term valuations, these companies looked incredibly high, but a lot of that has come down. It’s likely we will see real profits and real earnings, and looking out long term, that looks good for us.”

Consumer discretionary stocks are likely to report the largest year-over-year earnings decline of all 11 sectors, slumping -2.2 per cent. 

A considerable gain in oil prices this year have left the energy sector expecting to report the highest revenue growth at 17 per cent.

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