U.S. Equities Are Looking Exceptionally Strong Again (IVV)

From BlackRock: We have upgraded our view of U.S. stocks and shifted to neutral on European equities. Richard Turnill explains why.

We have upgraded our tactical view of U.S. equities to overweight from neutral. The reason: Impending fiscal stimulus is supercharging U.S. earnings growth expectations. We have shifted our view on European equities to neutral as a result. Earnings momentum is solid in Europe–but lags that of other regions

Our U.S. upgrade boils down to a fundamental story underpinned by earnings growth. An added bonus: U.S. valuations look slightly more attractive after the February stock market swoon. Economic strength was already changing the tone of earnings momentum, but U.S. tax cuts and government spending plans lit a fire under the trend. The chart below illustrates the sharp acceleration in U.S. earnings upgrades as analysts factored in the stimulus.

The ratio of upgrades to downgrades for U.S. large caps (the orange line) stands at the highest level since the data series started in 1988. Upward revisions are solid globally, but the U.S. strength is unmatched. Japan is unique, as earnings revisions there tend to be noisy. We see the strong U.S. earnings momentum persisting in the short term and leading to higher returns.

Earnings growth eclipses valuations

U.S. earnings growth momentum was already strong before the announced tax cuts and fiscal stimulus, thanks to an improving economy. Earnings growth for S&P 500 firms was 15% year-over-year in the last quarter of 2017, and sales growth was the highest since the third quarter of 2011. Some 60% of the S&P 500 companies providing guidance during fourth quarter earnings season exceeded what analysts had penciled in for 2018. Companies have had an incentive to give conservative forecasts as stocks that disappointed on earnings and sales have been disproportionately punished in recent quarters. U.S. earnings estimates have jumped by more than seven percentage points to 19% growth for 2018, as analysts factored in corporate guidance and the stimulus benefits.

Read more from Richard.

U.S. stocks have already retraced a large part of their early February losses, but we believe the coming positive effects of new U.S. tax and spending plans are still underappreciated by markets. Valuations are certainly still at the top end of their historical range and we see little scope for equity multiples in the U.S., or most other regions, to expand further. But we find earnings growth matters more than valuations over shorter time horizons at this stage of the bull market. We are in the ninth year of an unusually long economic expansion, and while we believe the cycle has room to run, we see gradually rising rates and modestly higher inflation ahead.

We see earnings-per-share (EPS) growth and dividends fueling returns. Some companies will choose to spend their tax windfalls on buybacks or dividends; others will boost capital spending. The scope for additional M&A activity is also large. The risks? Accelerating inflationary pressures could threaten margins and rising real rates may lead to lower multiples. We see the tax windfall providing an earnings buffer against these forces. We maintain high conviction in equities overall. We see solid European equity returns ahead, but lower earnings growth relative to other regions limits European stocks’ potential to outperform in the short term. Emerging markets remain a favored region. In the U.S., we like the momentum and value factors, financials and technology firms. Read more market insights in our Weekly commentary.

Richard Turnill is BlackRock’s global chief investment strategist. He is a regular contributor to The Blog.

In the latest episode of The Bid podcast, our Chief Fixed Income Strategist Jeff Rosenberg talks about the risks we foresee in the year ahead and the role of fixed income in a market environment that’s heating up.

The iShares S&P 500 Index ETF (IVV) fell $0.40 (-0.15%) in premarket trading Wednesday. Year-to-date, IVV has gained 1.70%.

IVV currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #2 of 141 ETFs in the Large Cap Blend ETFs category.

This article is brought to you courtesy of BlackRock.