Stocks continue to hit new highs. And the market’s current record run is coming from an unexpected source… corporate earnings.
Heading into the current reporting season, analysts were pessimistic. For the third quarter, they expected the earnings of S&P 500 Index member companies to fall 4.6%.
So clearly, they expected that the negative headlines would be baked into company results.
That turned out to be a blessing, though.
All that pessimism has made it easy for companies to beat estimates.
Companies have beaten earnings expectations at a huge pace this quarter.
That’s helped propel stocks higher. Plus, there’s another reason we could see this rally continue in the coming weeks.
Let me explain…
Through the end of last week, 92% of the S&P 500’s companies have released earnings. A huge 75% of those companies reported an earnings-per-share beat, versus the five-year average of 72%. Earnings have tended to be 3.9% better than expected.
Sales have also been better than expected, too. So far this season, 60% of companies have reported better-than-expected sales. And those sales have been 0.8% above expectations. The blended revenue growth rate has been 3.1%, picking up steam from 2.8% a couple of weeks ago.
The results caught the market by surprise. But they shouldn’t have. During this bull run, analysts have tended to underestimate earnings.
And it looks like Wall Street is setting itself up for a repeat in the fourth quarter.
In October, analysts began lowering their next earnings estimates even further, dropping them by 2.8%. That’s below the five-year average decline of 1.7% during the first month of the quarter. Since this summer, analyst expectations for the fourth quarter have dropped from growth of 5.6% to a decline of 1.4%.
Once again, Wall Street’s expectations could be overly conservative. It’s also worth noting that analysts are anticipating a rebound in earnings growth starting in early 2020. This all bodes well for stock prices going forward. But it’s not the only catalyst out there…
Even as the catalyst of earnings beats is removed from the market, another one will replace it: buybacks.
Companies are prohibited from repurchasing their shares in the weeks leading up to their earnings releases. So the end of the reporting season means they can resume buying back shares.
Take a look at the chart below. It measures the performance of the top 100 stocks with the highest buyback ratio in the S&P 500 Index.
Clearly, owning companies that buy back their own shares is a good thing. And it’s positive for the overall market, too.
Consumer-electronics giant Apple (AAPL) is the single largest corporate share repurchaser. It’s already announced fourth-quarter earnings, so the company is likely back in the market buying shares. And even though Apple is the biggest repurchaser, it’s far from alone.
Based on the activity in the first half of this year, S&P 500 companies will likely buy back as much as $1 trillion worth of stock in 2019. Not only would this break last year’s record of $806.4 billion, it would also provide support for the stock market heading into year’s end.
In short, negative sentiment is a big reason why stocks have been hitting all-time highs. Most companies have found it easy to beat Wall Street’s low expectations. Now, that negativity is setting the market up for a solid fourth quarter… And companies getting back out there to buy shares is another positive.
When you combine the two, it’s easy to see why stocks have been hitting – and should continue to hit – all-time highs. And it’s why you want to stay long right now.
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Source: Daily Wealth