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Is Trump Positive for Earnings?

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While the overall Q3 earnings season was fairly good, results from the Retail sector were mixed at best. Results from online vendors earlier in the Q3 reporting cycle failed to impress, while the restaurant results were similarly sub-par. The department stores generally came out ahead, but that was largely a function of low expectations and managements’ tough expense controls, particularly on the inventory side.

The Retail sector’s earnings growth in the quarter compared favorably with what we had seen in other recent quarters, but revenue growth lagged and positive surprises were hard to come by. In fact, the proportion of retailers beating EPS and revenue estimates in Q3 was one of the lowest of all 16 Zacks sectors.

Beyond Retail, the picture coming out of the Q3 earnings season was reassuring, with growth finally turning positive after 5 quarters of back-to-back declines. With results from 485 S&P 500 members already out, total Q3 earnings are up +4% on +2.6% higher revenues, the first positive earnings growth for the index in six quarters.

Estimates for the current period (2016 Q4) have come down, with total Q4 earnings for the S&P 500 index currently expected to be up +3.2% from the same period last year on +4.1% higher revenues. The +3.2% earnings growth in the quarter is down from +5.5% at the start of the quarter.

The outlook for earnings growth has improved following the election, with many in the market seeing the incoming administration’s policies giving the U.S. economy a much needed growth nudge. Driving this expectation is the hope that the combination of tax cuts, spending increases and regulatory overhaul will push the U.S. economy on a higher growth trajectory than has been the case over the last few years. Economic growth drives revenue growth, which translates into bottom-line gains.

The market’s overall favorable narrative about the incoming administration notwithstanding, not everything in the new administration’s policy package is earnings friendly.

The trade issue remains a big source of uncertainty following campaign promises of renegotiating existing trade deals, slapping tariffs on China and others, and an overall tough regulatory environment for companies that outsource manufacturing and other operations abroad. Given the absence of any policy details on the trade front at this stage, it is hard to measure what earnings impact we will see down the road. But there is no question that it will be negative for earnings. With more than 40% of S&P 500 earnings coming from beyond the U.S. borders, any restrictions on free trade will have a negative impact on earnings.

Another potentially negative factor is the renewed uptrend in the value of the U.S. dollar following the election. The dollar’s momentum partly reflects the market’s expectations of a Fed rate hike at the next Fed meeting. But the primary reason for the dollar’s strength is the improved growth outlook for the U.S. economy. We are seeing this show up in the rising treasury bond yields as well. Higher interest rates are good for bank earnings, but the resultant strength in the greenback is a headwind for most of the other sectors that earn big chunks of their earnings abroad.

These potential headwinds to the earnings picture resulting from the Trump administration’s expected policy package are meaningful. But they will likely be more than offset by the positive impact of a stronger economic growth on all sectors in general and the interest rate catalyst for the finance sector in specific. The bottom line is that the earnings outlook has improved following the election.

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