Analysts Have A Great 2017

Analysts get a lot of flak when they get caught changing their price targets and recommendations after an earnings surprise. I sometimes criticize them to make sure investors know not to take their word as gospel. If you are a beginner, you might think the 12 month price targets are where the stock will go. Because it’s extremely tough to predict where stocks will go in 12 months, these aren’t going to be exactly accurate. However, 2017 was a great year for analysts. The chart below shows the performance of stocks with buy recommendations. The first quintile shows the stocks with the highest percentage of buy rankings by analysts. The second quintile is the 2nd 20% grouping of buy rankings, etc. As you can see, the analysts were almost perfect when you look at the median performance. The only slight error is quintile 4 has a 0.1% higher median return than quintile 3.

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2017 was probably the best possible situation for analysts’ predictions to be accurate because there weren’t any exogenous events which caused stocks to correct. Either way, I still take the 3,000 price target JP Morgan has for the S&P 500 at the end of 2018 seriously. With recommendations looking great in 2017, let’s look at the forecasts for Q4. As you can see, the estimates haven’t moved much in the past 6 weeks. This is great news as the current average estimate is for 10.4% earnings growth and 6.6% revenue growth. The expectations on September 30th were 11.3% and 5.7% growth respectively. The estimate for 2017 earnings also hasn’t moved much because Q4 is the only quarter left in the year.

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The 2018 earnings estimate is up in the past few months as you can see from the chart below. Even just looking at the first few months of data, this year is looking unusual as it’s the only year with estimates increasing. Even 2017, which had the best earnings results in years, can’t compete with 2018. The current 2018 estimate is $146.26. JP Morgan’s estimate went from $143 to $153 because of the tax cuts. I can see the average estimate increasing in the next few months because of the tax cut. The stock market will price in the analysts’ changes before they happen.

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GOP Inches Closer To Passing The Tax Cut

The stock market rallied sharply on Monday as the hopes for the GOP tax plan become realized. The S&P 500 was up 0.54% and the Russell 2000 was up 1.21%. The S&P 500 is now up 20.16% year to date. The S&P 500 has been up 20% or more 18 times since 1950. It has moved up the next year 16 times. The Dow was up 0.57% which is a new record. This is the 70th record of the year which is the most since at least 1910. This month is about to be the 14th consecutive positive month for the S&P 500, making it the longest streak since at least 1928.

Senators Susan Collins and Mike Lee announced on Monday that they would vote in favor of the tax plan, meaning it will likely pass this week. Mike Lee supports the plan because of the increase in the child tax deduction and Susan Collins supports the plan because of the restoration of the $10,000 deduction for state and local property taxes and the lowered threshold for medical expense deductions. Since Senator McCain is fighting brain cancer, 2 more Senators voting against the tax plan can sink it. Senator John Flake is the only one who hasn’t announced if he supports the plan, meaning it will pass. Senator Corker said he’d support the plan on Friday. The chart below shows the improvement in after tax income from various income group because of this plan. As you can see, the biggest beneficiaries are those who make between $200,000 and $1 million per year. The trade could be to buy retailers who sell to rich customers.

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Inflation Hasn’t Cooperated In The Past 17 Years

Inflation hasn’t met expectations this year, but that’s been the norm for the past 17 years. The chart below has a great target board which shows where Europe, Japan, America, and the U.K have seen in inflation hit since 2000 and since 2010. As you can see, America has been moving away from the target of 2% inflation as the average since 2010 has been 1.5%. If you were to take Neel Kashkari’s logic that the Fed can make up for lost inflation, the Fed has 5.1% of inflation work with from the past 17 years. That could mean the Fed would be fine with 3% inflation for the next 5 years. That’s a theoretical possibility. Neel won’t be able to vote next year, but he gets that power back in 2019, so he’s not irrelevant.

Europe has also been moving in the wrong direction. It will be interesting to see if the end of QE causes inflation to fall. That could mean deflation is coming in 2019. Japan knows about deflation as it has had -0.1% core CPI since 2000. It has utilized equity ETF buying to help it get inflation to 1.1%. The BOJ is considering ending that program because policy makers are worried that the stock market is starting to get impacted by it. The the BOJ owns 2.7% of the Japanese stock market.  Finally, the U.K. is the only country which has met the target as inflation has been 2.0% since 2000 and 2.2% since 2010.

This target chart wouldn’t be relevant if inflation were to increase because it can get out of hand. We might see the reversal of this target in the next decade, with larger numbers in the outer rings of the target.

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Conclusion

Even though it will be tough to repeat 2017, 2018 might also be a great year because earnings results look like they will be great. On the flip side, the bar has been raised, making it tougher to meet expectations. I don’t think the tax cuts have been completely priced in yet, so the start of the year will look good at least. Surprisingly, the fiscal stimulus is going to take the reins from monetary policy as the Fed raises rates and unwinds the balance sheet. Congress backed into coordinated policy with the Fed. It would be great if the economy didn’t need training wheels at the end of the expansion, but investors can’t complain about the near term results.