Once again, the markets have had a nice market bounce, although off the highs as rallies have been fading into the afternoon like clockwork.  The world is preparing to watch Facebook’s CEO Mark Zuckerberg testify before a joint hearing of the Senate Judiciary and Commerce Committee.  That could add pressure to the market, but I think afternoon weakness is part of the program of shaking out weak hands.  

This morning’s release of the NFIB Small Business Optimism Index showed drops in key segments, but overall, its holding its post-election bounce.  The index for March slipped to 104.7 from February’s 107.6, the second highest reading in the history of the index.   Taxes were the big winner, receiving the fewest votes as the #1 business concern since 1982. 

Positive profit trends declined 1 percentage point, but it was still one of the best readings in the survey’s history.  Reports of earnings gains surged 11 points in January and remains elevated.  The report highlights the fact that small businesses are responding well to resent economic policy changes.

Earnings season is upon us and strong results are expected as can be seen in S&P company guidance for the first quarter.  Fifty-three companies issued positive guidance versus 52 issuing negative guidance. The number of companies issuing positive guidance is above the five-year average (28), while the number of companies issuing negative EPS guidance is below the five-year average (80).  

Information Technology had the highest number of companies issuing positive EPS guidance, 26 versus the five-year average of 11 for the sector.  The main reasons are related to increased revenue guidance and an increase in EPS due to the lower tax rate for 2018.    Several companies in this sector discussed the impact of the tax law on EPS guidance for Q1 2018 and Fiscal Year 2018 during earnings calls or in earnings releases.  Information Technology is the second highest weighted sector in our Hotline model portfolio, with a 3 weighting.

Earnings growth for the first quarter of 2018 is anticipated to be 17.3%.  If the growth rate comes in at 17.3%, or higher, it will mark the highest earnings growth rate since the first quarter of 2011 when the growth rate came in at 19.5%. 

Valuation:

Currently, the S&P 500 trades at a PE of 24.10, earnings on the S&P 500 in 2017 were $110.98.  If we use the 17.3% anticipated earnings growth rate, then S&P 500 earnings will be $129.85, and the PE would be 20.43 at the S&P’s currently price of 2,655. 

Our preferred method is the forward 12-month P/E ratio for the S&P 500, which is currently 18.80, down from 24.79 last quarter and 24.79 one year ago. Fundamentals remain positive:

•          Solid global growth
•          EPS growth strong
•          Household income increasing, employment strong 
•          Potential for higher home ownership

Strong earnings may be built in to the markets, as it is not new news.  The key will be in the guidance.  Investors will be looking at buybacks and CAPEX spending.  Increased CAPEX due to lower taxes rates would be welcome news to the markets.  Uncertainty related to tariffs will also be closely watched.  Are company’s holding back on spending due to the tariff uncertainty?  The fundamental backdrop remains in place, and the recent correction has taken some of the excess optimism out of the markets, setting us up for what should be a strong earnings season.