Why U.S. corporate earnings could boom in 2018

Heading into February, the U.S. corporate earnings outlook was “the best it’s been in years,” says Paul Roukis, who expects strong growth in 2018.

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Roukis, managing director and portfolio manager at Rothschild Asset Management in New York, says that’s good news for your clients’ portfolios, because “ultimately corporate profits drive stock returns.”

In spring 2017, Roukis’ take on corporate earnings was a forecast of 8% growth for the year, with implied earnings-per-share (EPS) of $135 to $138 for the S&P 500. For 2018, he’s expecting companies’ earnings growth could reach even higher.

“Fast-forward to today, and that growth rate is [already] closer to 13% or 14%,” he said during a Feb. 1 interview, before the early-February market correction. At that rate, this year’s corporate EPS would top $150, he says. Roukis’ firm manages the Renaissance U.S. Equity Value Fund.

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“That’s a pretty impressive growth rate,” he added, saying that was one of the main reasons stocks “had been able to sustain their multi-year rally.”

But the question remains: what’s been driving corporate earnings growth? Roukis highlights three factors.

• Global economic expansion

After struggling for years, parts of the global economy are once again growing at faster rates, says Roukis. “In particular, much of Europe is recovering, and it’s now looking at about 2% to 2.5% growth in 2018,” he explains.

There was already some evidence of recovery last year. The European Commission said in its winter 2018 interim economic forecast that the EU economy was estimated to have grown 2.4% in 2017—the fastest pace in a decade.

Roukis notes China’s GDP is projected to continue growing steadily, at about 6% to 7% a year.

• Supportive monetary policy

Central banks are continuing their unprecedented support of the market, Roukis notes. For instance, in Japan, the central bank voted during its two-day January meeting to keep its interest rate at -0.1%, and said it’s committed to quantitative easing until the economy is consistently above its 2% target inflation rate. In Switzerland, the central bank’s interest rate is -0.75%. In England, the central bank maintained the bank rate at 0.50% on Feb. 8, and its quantitative easing program is currently worth £435 billion.

While larger banks such as the Fed are winding down their policies, it’s a slow process.

“The spigots don’t shut off overnight,” says Roukis. “It will take time for monetary policy to normalize—measured in years, not quarters.” He adds central banks’ past actions have shown that in moments of market uncertainty, they’re willing to step in with more dovish policies to give investors peace of mind.

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After years of stagnant growth of around 2%, the U.S. economy was forecast to finish 2017 with an expansion rate of close to 3%, says Roukis—and it’s on track to do just as well, or better, in 2018.

Read: U.S. economy grew 2.6% in Q4, backed by consumer spending surge

“While fourth-quarter real GDP was estimated at 2.6%, the underlying economy seems much stronger, when you exclude volatile components like inventory and trade,” he explains. “So you’re looking at much better growth than at 2.6% would be implied.”

One of the factors fueling this growth in 2018 will be U.S. tax changes. The Tax Cuts and Jobs Act of 2017 has ruffled some feathers, with some economists saying the bill hurts middle-class Americans. But on Jan. 1, it also brought in the largest one-time reduction in corporate taxes in U.S. history, bringing the corporate tax rate down to 21% from 35%.

“The tax reform bill is a game changer,” says Roukis. “This is not an accounting gimmick, it has real influence on corporate cash flows, and where and how much capital will be invested.”

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President Trump’s tax reform will impact both U.S. and foreign companies, as it makes the U.S a more favourable place to invest, says Roukis. Further, the administration’s general pro-business stance might help corporations as government regulations, which in theory have constrained business activities, are stripped away.

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