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US blue-chips’ double-digit earnings set to continue

The S&P 500 and Dow Jones Industrial Average rose to fresh closing highs on Monday, both boosted in recent months by earnings growth on the back of a global economic recovery and weakening US dollar.

“As long as we have the earnings growth, no one seems to care that President Trump’s agenda doesn’t have a lot of traction,” said Dave Lafferty, chief market strategist at Natixis.

With 84 per cent of the companies in the S&P 500 having reported their earnings for the past quarter, a blended rate of the actual results and analysts’ forecasts indicate that earnings rose 10.1 per cent year-on-year, according to FactSet.

At that rate, companies are on track for the second-highest year-over-year growth since the fourth quarter of 2011 and the first time companies in the index have seen two consecutive quarters of double-digit growth since the third and fourth quarters of 2011.

The return of earnings growth in the US comes after a five-quarter run of shrinking earnings that ended in the third quarter of last year.

“Following the mini recession with respect to profits, growth has been widespread and stronger than expected,” said John Adams, senior investment strategist at BMO Global Asset Management. “Weakness in the US dollar has driven markets higher and will be supportive of corporate earnings.”

For shares of large multinational companies, the return of earnings growth has been enough to outweigh the struggles the Trump administration has faced, including in pushing ahead with its pro-business policies of tax cuts and infrastructure spending.

Small capitalisation companies that have less international exposure have been more vulnerable to what are perceived as delays on the Trump agenda. Smaller companies tend to pay higher tax rates since they don’t benefit from having cash flows in different countries with different tax regimes.

With a gain of 4.2 per cent year to date, the Russell 2000 index of small-cap stocks is lagging the Dow and S&P 500, which are up nearly 12 per cent and nearly 11 per cent, respectively. Some of the performance could be a reversal of late 2016 when small-caps outperformed.

“Additionally, the Washington policy initiatives getting pushed to the right have soured sentiment for domestically-oriented, high taxpayers among US companies,” said Bryan Reilly, a senior investment analyst for CIBC Atlantic Trust Private Wealth Management.

Earnings season is always a game of expectations and crucially companies are also beating Wall Street projections by even more than is typical. On June 30, estimates were for an increase of 6.4 per cent in EPS.

Led by the healthcare, financials and information technology sectors, more are beating expectations and by a wider margin than the five-year averages. Among the companies with big upside surprises for the quarter were Apple, Gilead Sciences and JPMorgan Chase.

A rebound in the energy sector from a period of stress in 2016 when oil prices sharply fell has helped to boost overall earnings growth. Excluding the energy sector, earnings are up 7.8 per cent in the second quarter.

The year-over-year comparisons become more difficult looking forward, which is one reason why expectations for the third-quarter earnings gain are just 5.6 per cent. At the same time, the political noise could seem louder as Congress confronts raising the debt ceiling.

“Why does it seem like no one cares yet? Because the fundamentals are improving,” said Mr Lafferty. “But will that still be the case, say, in the second week of October?”