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Earnings, Tax Overhaul Give Markets Their Mojo Back

By John Persinos on October 26, 2017

Mr. Market could use some Lithium. On Wednesday, weak earnings numbers sent him into a funk. The usual buffoonery in Washington didn’t help. The next day, strong earnings and forward movement on tax overhaul shifted his mood to elation.

A fresh batch of positive third-quarter earnings reports powered markets higher on Thursday. Stocks also got a lift from House passage of a Senate-backed budget bill. This procedural action cleared the way for the first major change of the tax code since 1986.

Wall Street yearns for lower taxes, but hurdles remain. Some lawmakers view certain provisions of the proposed tax bill as regressive, such as its curtailment of the state and local tax deduction. But no matter. Investors these days greet any action on Capitol Hill with gratitude.

Thursday was one of the busiest days of the earnings season. Of the roughly 170 S&P 500 companies that have reported so far, more than 72% have exceeded expectations.

Four technology titans are scheduled to report earnings on Thursday after the market closes: Alphabet (NSDQ: GOOGL), Amazon (NSDQ: AMZN), Microsoft (NSDQ: MSFT) and Intel (NSDQ: INTC). Year to date, the tech sector has outperformed the broader indices. The operating results of this quartet will provide clues as to the bull’s staying power.

Investors are paying close attention to cloud revenue, as Amazon’s competitors seek inroads into the e-commerce giant’s dominance of this fast-growing segment.

Valuations are lofty, prompting analysts to harshly judge corporate scorecards. The forward 12-month price-to-earnings ratio (P/E) for the S&P 500 is 17.9, above the 10-year average of 14.1.

Earnings have been good, but investors want to see stellar numbers to justify high multiples. On Wednesday, stocks suffered their worst decline in seven weeks as key earnings reports disappointed Wall Street. The numbers on Thursday brightened moods again, although the struggles of chip makers weighed on the tech-heavy Nasdaq. Here’s your session snapshot:

Thursday Market Wrap

  • DJIA: +0.31% to close at 23,400.86
  • S&P 500: +0.13% to close at 2,560.40
  • Nasdaq: -0.11% to close at 6,556.77

Thursday’s Big Gainers

Social media platform predicted profitability in the fourth quarter.

Railroad’s quarterly profit grew in the face of headwinds.

Software firm blew past earnings expectations.

Thursday’s Big Losers

Biotech missed on 3Q earnings and lowered guidance.

Cable company lost subscribers and posted weak 3Q results.

Document management firm beat on earnings but missed on revenue

Letters to the Editor

Let’s dive into your emailed questions.

Energy sector debt…

“As an investor, should I worry about energy sector debt?” — Gary C.

Outstanding loans to the energy industry total $123 billion. This debt is getting harder to service. Energy prices bounced back in the second half of 2016 but now fluctuate within a tight range.

On Thursday, West Texas Intermediate rose 47 cents to close at $52.65/bbl. Brent North Sea crude rose 86 cents to close at $59.09/bbl.

The number of expected bankruptcies in the energy sector this year stands at about 500. Your smartest strategy is to look for energy stocks with the lowest ratios of long-term debt-to-equity. They’re less vulnerable to oil price swings; they’ll also grow the fastest when prices take off again.

The total debt to equity ratio measures a company’s financial leverage. A high ratio reflects more financial risk because of higher interest costs. Stick to low-cost producers with strong balance sheets and abundant proven reserves.

Valuation yardsticks…

“You warn that stocks are overvalued. How do you define overvalued? The classic P/E ratio or PEG isn’t enough. What other metrics should I look at?” — John M.

It’s not just price-to-earnings or price/earnings to growth ratios that are raising red flags. By almost every measure, this bull market is frothy. Important valuation metrics include:

Price-to-book ratio (P/B), which indicates what investors are willing to pay for each dollar of a company’s assets.

Price-to-sales ratio (P/S), which is the value placed on each dollar of a company’s sales or revenues.

Enterprise value-to-EBITDA, determined by dividing a company’s enterprise value (EV) by its earnings before interest, taxes, depreciation and amortization. This metric allows investors to compare the value of a company (debt included) to the company’s cash earnings less non-cash expenses.

Got questions or feedback? Drop me a line: mailbag@investingdaily.com — John Persinos.

This Day in History

October 26, 1825: The Erie Canal opens, connecting the Great Lakes with the Atlantic Ocean via the Hudson River. The canal cost $7 million and ran 363 miles from Albany to Buffalo.

New York Governor DeWitt Clinton led the opening ceremonies. Before construction of the canal, shipping goods west from Albany was slow and expensive. The canal was an engineering marvel that boosted the regional and national economies.

The Erie Canal teaches us that infrastructure development is vital to economic growth. Today, America’s transportation system is crumbling. President Trump has promised to spend billions of dollars on infrastructure, but political gridlock stands in the way.

As Congress drags its feet, state and local governments are stepping up to the plate. Across the country, mayors and governors are increasing expenditures on infrastructure.

If you’re looking for an investment trend, consider U.S. construction firms. They face booming prospects as America repairs its neglected public works.

Number of the Day: 78%

Of the companies that were traded on U.S. stock exchanges in 1950, 78% of them have disappeared. This statistic suggests that companies are locked in an endless struggle to survive. It’s adapt or die.

The lesson for investors is that the “buy-and-hold” strategy doesn’t work anymore. Even blue chips are vulnerable to disruptive technology. Dominant companies don’t stay on top forever. That makes methodical stock picking all the more important.

You can’t put your portfolio on automatic pilot; it requires constant calibration. That’s where we can help.

Quote of the Day

“All I ask is that I get the chance to prove that money can’t make me happy.” — Spike Milligan

 


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