Earnings Heat Up

As we head into the back half of summer, company earnings are heating up while market volatility has declined to an all-time low. We also have an update from the continued fallout in retail after Amazon's purchase of Whole Foods. Let's dive in.

Earnings

An important issue for the market coming into 2017 was the quest for a return to strong growth in company earnings. After 5 quarters of flat or negative earnings growth, the 1st quarter of 2017 saw growth of 14%, a blockbuster number. The next question was whether the 1st quarter number was a fluke or if the strong growth would continue?

With over half the companies in the S&P 500 reporting 2nd quarter numbers, profits are on pace to grow by 11%. It is this growth that has helped to power the stock market to record highs. 72% of companies in the S&P 500 have beaten their earnings estimates compared to the long-term average of 64%. 

Another piece of good news is that revenue growth is up 5% for these companies with 69% beating expectations vs a long-term average of 59%. 

As long as healthy earnings growth continues, the path of least resistance for the market is higher.

Volatility

One of the most important measures of market volatility, the CBOE Volatility Index(VIX), hit an all-time low within the last week. The VIX tends to spike higher when stocks sell-off or when market participants are fearful. With the VIX at record lows there is a debate about whether investors have become too complacent. However, according to Bank America investment managers are holding above-average levels of cash in their portfolios. Also, there is a high level of "short interest" in stocks, that is betting that stocks decline in value. These are not signs of a market with excessive optimism. Typically when the market is close to a near-term top investment managers have very little in cash and short interest is low.  

Amazon Impact

Since Amazon's announced purchase of Whole Foods on June 16th, many companies from all walks of retail have seen their stocks sell-off. 

Here is a look at how far some strong companies have fallen from their 52 week highs in large part due to concerns of competition with Amazon:

Costco -17%

Kroger -31%

Auto Zone -30%

Ulta Beauty -20%

Target -27%

There is no question that Amazon has disrupted the business model of many retailers. Many department stores as well as specialty retailers have gone up in flames as they were unable to adjust to Amazon.

That said, there is a limit to how many business segments Amazon can dominate before the government becomes concerned with a monopoly status. We aren't there yet, but as the retail shakeout continues there will be some buying opportunities in the space as the baby gets thrown out with the bathwater.   

With the majority of companies in the S&P 500 having reported 2nd quarter earnings, the results have been very good, extending the earnings recovery that began in the 1st quarter. The market response to earnings has been to move higher with low volatility. Whether investors have become too complacent or not will become clearer as we head into the fall. While there will still be values to be found, whether related to the Amazon impact or not, we will continue to closely monitor your portfolios.