Macro Background Positive for Stocks: Q417 Corporate Profits Next

The macroeconomic and policy backgrounds are now very positive for the stock market.  As a result, stocks should continue to rally into February.  Even if there is some profit taking after the tax cut is passed and signed into law, the pullback should be short-lived thanks to the other positive fundamentals.  Treasuries are likely to remain range bound, as yields are held down by low inflation.

The economy is strong.  The Atlanta and NY Fed models now project 3.3-4.0% for Q417 Real GDP Growth, and the NY Fed model's early call is 3.2% for Q118 GDP.  The weather is a big unknown for Q118.  But, if GDP is held down by bad winter weather, it should rebound in the Spring.

Fiscal and monetary policy are pro-growth.  On the fiscal side, the tax cut should boost the bottom line of corporations, if not the economy, next year.  On the monetary side, the Fed is sticking to a gradual pace of rate hikes for 2018, despite having lifted its economic growth forecast for 2018.  The next potential Fed rate hike is not until the March FOMC meeting.

The next round of corporate earnings reports, for Q417 and mostly due in January-February, is expected to be strong.  Consensus looks for a +10.6% y/y increase in Q417 S&P 500 earnings, up from 8.6% in Q317.  Indeed, the macro evidence points to good corporate profits.   The weaker dollar and solid foreign economic growth should help the bottom line of corporations with earnings abroad.  The oil sector should continue to be boosted by higher oil prices.  Overall price and wage inflation do not suggest any significant reduction in profit margins.   The only apparent drawback is a difficult comparison with profits in Q416, as the latter were strong according to the GDP measure of corporate profits.  That is, the y/y comparison should be more difficult for Q417 than it was for Q317.   

                                                                                                                                          Markit
                                                                                                                                          Eurozone              Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level)
Q316            1.5                 -3.4                    2.2                              2.6          2.2
Q416            1.8               +16.4                   3.9                              2.7          2.2
Q117            2.0                +65.3                  2.3                              2.7          2.2                55.6
Q217            2.2                +13.1                  3.1                              2.5          1.8                56.8
Q317            2.3                 +6.0                 -1.9                              2.5           1.7               57.4
Q417            2.6-2.9           +5.0                 -4.1                              2.4           1.6               57.2