Global GDP growth is likely to be a robust 4% in 2018, giving stock prices further upward impetus, Goldman Sachs Group Inc. (GS) is telling clients, according to a report by CNBC. Unexpectedly strong third quarter results were delivered by the U.S., with 3% annualized GDP growth, and Germany, the largest European economy, which posted 0.8% growth. Japan, meanwhile, has posted seven straight quarters of economic expansion, CNBC adds.
Investors around the world have responded to improving economic fundamentals by sending equity prices soaring. For the year-to-date through Monday's close, the S&P 500 Index (SPX) is up by more than 15%, the German DAX Index by over 13%, and the Japanese Nikkei 225 by over 16%, per Yahoo Finance. Another potential boost to U.S. stocks in 2018: Goldman gives 80% probability that a tax reform package will emerge from Congress early in 2018, with a positive impact on corporate earnings. (For more, see also: Why the S&P 500 Could Rise to Over 3,000 in 2018.)
Earnings Headed Upward
EPS for S&P 500 companies have risen by 6.2% in the third quarter, and revenues by 5.9%, versus the same period in 2016. This is based on the 95% of companies that have reported through November 17, according to FactSet Research Systems Inc. Of those companies reporting so far, 74% delivered positive earnings surprises and 66% posted positive revenue surprises, both of these figures being above their five-year averages. Reported EPS and revenues have beaten estimates by average margins of 4.5% and 1.1%, respectively, FactSet adds. Moreover, seven of the 11 S&P 500 sectors, led by energy, have reported overall earnings increases for 3Q 2017.
Effect of High Expectations
The 12-month forward P/E ratio on the S&P 500 is now 18.0, per FactSet, above its five-year and ten-year averages, respectively 15.7 and 14.1. The forward P/E also has risen from 17.8 on September 30, at the close of 3Q 2017. Increasing concerns about rich valuations may pose a potential obstacle to further share price gains.
Meanwhile, continuing a trend that has been noted for much of 2017, FactSet observes that "the market is rewarding upside earnings surprises less than average and punishing downside earnings surprises more than average." Looking at price moves from two days before earnings releases through two days afterwards, FactSet finds that, in 3Q 2017, positive surprises are associated with average gains of +0.6%, while negative surprises are producing average losses of -3.5%. By comparison, the five-year averages were, respectively, +1.2% and -2.4%.
The consensus of analysts is that S&P 500 EPS will grow, year-over-year, by 10.0%, 10.5% and 10.1% for 4Q 2017, 1Q 2018 and 2Q 2018, respectively, per FactSet. The projections for revenue growth are 6.4%, 6.6% and 6.3%, respectively. For full year 2017, growth rates of 9.5% in EPS and 6.3% in revenue are being forecasted.
Through what it calls a bottom-up analysis of analysts' estimates, FactSet derives a 12-month target price of 2,820.72 for the S&P 500, more than 9% above its close on November 20. Out of 11,035 ratings on S&P 500 stocks, FactSet notes that 49% are Buys, 46% are Holds and 5% are Sells.
Beware the Fed
Last week, a number of key markets around the globe endured short-lived pullbacks, but disappointed bearish short sellers by rebounding as the result of vigorous buying on the dip, CNBC reports in another article. Even the prices of high yield, or junk bond, debt recovered after a brief selloff that some bears heralded as the harbinger of their long-awaited correction in equities prices. Last week, the S&P U.S. High Yield Corporate Bond Index returned quickly to its pre-selloff value, per Dow Jones S&P Indices.
On the other hand, Goldman Sachs has sounded a bearish note by predicting that the Federal Reserve will raise interest rates four times in 2018, in response to strong economic and employment growth, per Reuters. Prominent bullish strategists Joseph Zidle of Richard Bernstein Advisors and Jonathan Golub of Credit Suisse Group (CS) are among those who believe that excessive tightening by the Fed is the biggest risk for the equity markets. (For more, see also: Get Ready for the Coming Bear Market and Recession.)