Wall Street Gives Earnings Outlook a Big Thumbs Up

On the topic of trade, Wall Street has come to the conclusion that Donald Trump is all talk. That’s a good thing. If investors thought that the president really intends to follow through on his protectionist rhetoric, the stock market would tank.

The main indices sharply rose Thursday, as worries about a trade war with China eased. Investors consulted their silver linings playbook: economic growth and robust earnings expectations. Today marked the best three-day gain since Trump’s election.

The White House managed to avert a market meltdown late yesterday, when officials issued conciliatory statements on trade. They insisted that the latest U.S. proposals of steep tariffs against Chinese goods were merely threats designed to wring concessions from China. When the markets opened today, investors eagerly bought the argument and stocks shot higher.

Problem is, brinkmanship is a dangerous game. Threats (even empty ones) can erode trust among antagonists. A war of words can spiral out of control and become a real war — either a trade war, or a shooting war. As long as this international “game of chicken” continues, markets will remain under a cloud.

But investors today focused on the bright spots. For the first quarter of 2018, the analyst consensus is that year-over-year earnings growth for the S&P 500 will come in at 17.3%. If that pace is actually achieved, it will mark the highest earnings growth since the first quarter of 2011, when the pace was 19.5%.

Since the 10% correction in the first quarter, concerns about overvaluation have diminished. The S&P 500’s forward 12-month price-to-earnings (P/E) ratio stands at 16.1. This P/E ratio is equal to the five-year average of 16.1.

Nonetheless, a handful of mega-cap stocks that have been driving the bull market are still pricey. First-quarter earnings results will help investors determine whether these lofty expectations are warranted, especially in the technology sector.

Tailwinds for earnings growth include synchronized global expansion and the new U.S. tax bill that slashes the corporate tax rate. Among the 11 major S&P 500 sectors, the energy sector has issued the biggest increase in expected earnings growth since the start of the first quarter, from 57.1% to 80.4%.

Rising oil and gas prices are a boon for the energy patch as well as the broader markets. Accelerating energy demand is interpreted as a sign of economic strength. With the price of crude hovering above $60 per barrel, once-beleaguered energy companies are off the ropes and thriving. The U.S. crude benchmark West Texas Intermediate rose 28 cents today to close at $63.65 per barrel.

Analysts expect earnings for S&P 500 firms to continue growing at double-digit levels for the remainder of fiscal 2018. Healthy economic conditions provide the impetus. The World Bank estimates that global economic growth will reach 3.1% in 2018, a solid pace that follows a stronger-than-expected 2017.

And yet, headline risk should not be underestimated. Trade war anxieties continue to loom large. The White House is dominated by hawks on trade, with no competing voices for President Trump’s ear.

The specter of cybercrime…

The volatile technology sector is another wild card. Tech stocks remain under pressure from the Facebook (NSDQ: FB) privacy scandal, which poses troublesome implications for Silicon Valley.

Reports emerged today that the data of up to 87 million Facebook users may have been improperly shared with the Trump campaign’s political consulting firm Cambridge Analytica. That number is much higher than the originally estimated 50 million. Facebook also warned that “most users” have had their data harvested by third-party apps.

Facebook CEO Mark Zuckerberg is scheduled to appear before the U.S. Senate for two days, April 10-11. The hoodie-wearing billionaire is likely to get a tough grilling by indignant lawmakers. The business model of not just Facebook but other tech giants, such as Alphabet’s (NSDQ: GOOG) Google, could get threatened by stricter regulation.

But as the second quarter gets underway, the tech sector also faces several advantages. The tax bill makes it easier for tech firms to repatriate cash parked overseas. They’ll use this cash to fund internal innovation. Historically, a company’s research and development is positively correlated with its stock performance. One profitable area of research is cybersecurity, as hacking incidents dominate the front pages. With these positive elements as a backdrop, the five FAANG stocks all ended in the green today.

Looking ahead, the biggest danger is that the politicians in Washington will commit unnecessary acts of economic self-harm. To use a famous phrase coined by newspaper cartoonist Walt Kelly: “We have met the enemy and he is us.”

But for now, the bulls are ignoring the dreariness of contemporary politics and focusing on the favorable fundamentals.

Thursday Market Wrap

  • DJIA: +0.99% or +240.92 points to close at 24,505.22
  • S&P 500: +0.69% or +18.15 points to close at 2,662.84
  • Nasdaq: +0.49% or +34.44 points to close at 7,076.55

Thursday’s Big Gainers

  • GMS (NYSE: GMS) +10.09%

Building materials maker expands through acquisitions.

  • SandRidge Energy (NYSE: SD) +9.07%

Investor activist Carl Icahn pushes for boardroom changes at energy producer.

  •  LSB Industries (NYSE: LXU) +7.39%

Analysts impressed by chemical maker’s new management.

Thursday’s Big Decliners

  • Conatus Pharmaceuticals (NSDQ: CNAT) -31.44%

Biotech’s new liver drug stumbles in clinical test.

  • AnaptysBio (NSDQ: ANAB) -7.45%

Biotech’s peanut allergy drug misses the mark in trials.

  • Allena Pharmaceuticals (NSDQ: ALNA) -5.18%

Analysts bearish on biotech’s prospects.

Letters to the Editor

“Do health sector stocks pose market-beating opportunities in 2018?” — Sarah L.

With the uncertainty of Obamacare repeal off the table, health care stocks are breathing a sigh of relief. Managed care stocks, in particular, are positioned to rally this year.

The health services sector benefits from unstoppable demographic trends. Populations around the world are getting older (and sicker), demanding ever-greater levels of care. 

Medical care providers, hospital operators and drug makers are merging in their respective fields, to achieve economies of scale. The resulting survivors will make the best investment bets.

Questions about sector investing? Drop me a line: mailbag@investingdaily.com

John Persinos is managing editor of Personal Finance and chief investment strategist of Breakthrough Tech Profits.