What’s More Important than Profits?
The earnings season is underway, and it’s looking solid. Based on the first 154 S&P 500 companies to report for the first quarter of 2018, the average company is beating expectations by 7%, and we are on track for earnings to be at least 20% higher than first quarter last year.
Profit growth could be the highest on record since 2011, a very important confirmation to current valuations. We have discussed some of the drivers of higher earnings like tax reform, currency gains, and growing revenues. But, one crucial factor to monitor this season is business investment.
Business investment, known as capex, has many positives – from immediate effects like greater activity and demand, to longer-term effects such as increased efficiency and productivity.
Business Capex Remains Below Historical Norms
Sources: Thomson Reuters DataStream, New York Life Investments, as of 4/19/18. Past performance is no guarantee of future results, which will vary.
For most of this recovery, many corporations have remained cautious on investments, instead showing a preference for buybacks and preserving cash. The result has been “pent-up” demand for equipment, given a now tight labor market and the rapidly expanding digital economy.
On each earnings call, investors receive guidance from some companies on how they intend to spend their extra profits. Capex guidance provides a long-term assessment of future value creation and the direction for the company. Thus far, capex guidance is at a three-year high – a trend we expect to hold, given faster revenue growth.
Other indicators also point to a likely pick up in capex this year. Business surveys on capex expectations are far above historical norms.
With tax reform favoring capex and repatriation of overseas capital, an acceleration in business investment could underpin sustained growth and extend this economic expansion further.
Capex trends are key to watch for markets this year. Stay tuned!
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