February 5, 2017

Earnings Roundup: Is The S&P 500 Pricing In A Super Bowl Win For The ATL Falcons?

by David Aurelio

Earnings could indicate that the Atlanta Falcons (NFC) are favored over the New England Patriots (AFC) in Super Bowl LI. Earnings season was hit by a rush of 109 16Q4 results from S&P 500 companies to cross the 50 yard line and end the week with 55% of the index reported. The Information Technology sector helped drive Y/Y 16Q4 earnings 1.2 percentage points (ppt) higher to 8.0%, which puts the quarter on target to be the largest gain since the 10.3% growth in 14Q3. While 16Q4 earnings are stronger than expected, the S&P 500’s 7.4% gain since the election has 2017 earnings in focus.

According to the superstition behind Leonard Koppett’s “Super Bowl Indicator”, if the NFC team wins, the market will end the year higher. Therefore, as a finance professional, Broncos fan, and alumnus of Boston College, I’m rooting for Matt Ryan in this one. However, Patriots fans shouldn’t let the Super Bowl indicator get them down. Last year the Broncos (AFC) won, but the market ended 2016 higher with a strong post-election drive.

Exhibit 1. S&P 500 Expected Effective Tax Rates by Sector

Sources: Thomson Reuters Eikon, Thomson Reuters I/B/E/S

The “Trump Rally” has many investors questioning if markets have run too far, too fast. The S&P 500’s forward four quarter P/E ratio is currently 17.3%, which is above the long-term average of 14.8%. One reason the P/E ratio is likely above historical levels is that the market appears to be pricing in expectations for policy changes related to the new administration that aren’t incorporated in earnings estimates. One of the main expectations is for corporate tax reform.

Exhibit 1 shows a breakdown of the expected effective tax rates for S&P 500 companies with consensus estimates for 16Q1 through 17Q4. The effective 2017 tax rate for the index is expected to be 26.0%, well below the current 35% stated corporate tax rate. However, a comparison of the 2017 quarterly estimates shows that most analysts have not incorporated tax reform into their 2017 estimates, as the effective tax rates for the index are slightly higher than expected 25.1% for 16Q4.

Exhibit 2. S&P 500 PPT Increase/Loss to Y/Y CY2017 Earnings with a 20% Tax Rate

Sources: Thomson Reuters Eikon, Thomson Reuters I/B/E/S

The chart in Exhibit 2 shows that the S&P 500 could see an 8.7 ppt increase in Y/Y CY2017 aggregated earnings per share if corporate tax reform passes and results in a 20% effective tax. It’s worth pointing out that this is a rough approximation, because companies with effective tax rates below 20% are being penalized in this study. However, the boost in earnings implies the CY2017 bottom up EPS for the S&P 500 increases to $158.40 per share from $131.90 per share. As a result, the price to CY2017 EPS improves to 14.5 from 17.4. This P/E ratio of 14.5 is in-line with the long-term average forward four quarter P/E ratio 14.8.

Exhibit 3. S&P 500 PPT Increase to Y/Y Earnings with a 20% Tax Rate by Sector

Sources: Thomson Reuters Eikon, Thomson Reuters I/B/E/S

The market looks to be incorporating a ~20% effective tax rate for the S&P 500. However, even if corporate tax reform passes, it is unlikely to be implemented in time for 17Q1 results.

Download the full This Week in Earnings report here.

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