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Amid global tumult, U.S. corporate earnings continue to climb

U.S. companies are reassuring investors with stronger results after a weak first quarter.

Lucas Jackson/Reuters

U.S. companies are reassuring investors with stronger results after a weak first quarter.

At about the halfway point of second-quarter earnings season, higher profits and, to a lesser extent, revenues, are more than offsetting the heightened geopolitical threats in the wake of a first quarter that bore the ill effects of a harsh winter.

Since Alcoa Inc. unofficially kicked of the latest round of earnings on July 8, the S&P 500 index advanced by about 15 points by Friday's close, having slightly backed off the new record of 1,987.98 reached on Thursday.

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Friday saw some downside reaction to disappointing financials from both Visa Inc. and Inc., two closely-watched consumer discretionary stocks.

"Amazon and Visa are significant components of the overall market and bellwethers of their respective industries. That gives you pause," said Lawrence Glazer, managing partner at Mayflower Advisors in Boston.

Friday's selloff notwithstanding, investors have become more optimistic regarding both earnings and economic growth, said Peter Buchanan, senior economist at CIBC World Markets.

With 228 of the S&P 500 companies having reported so far, 66 per cent of them surpassed analyst expectations on quarterly sales, while 79 per cent beat on earnings, according to Bloomberg.

While earnings beats are often made possible by lower expectations in advance, the level of earnings surprises is high by comparison to previous quarters.

"The great surprise would be if that didn't happen," Mr. Buchanan said. "I think investors would be devastated if two-thirds didn't do better than estimates."

This earnings season has also seen the continuation of the trend of bottom-line growth being driven more by rising margins than rising revenues.

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The reporting companies have posted a total of $164.51-billion (U.S.) in profits, an increase of 11.2 per cent over the last year, on $1.25-trillion in earnings, which was up by just 5.2 per cent.

The gap between earnings and sales growth was made up by the ceaseless rise in profitability that U.S. corporations have wrung out of their businesses.

Profit margins are at record highs in large part as a result of cost cutting, debt refinancing and share repurchases.

"It's been about buybacks and financial engineering for a long time," said Greg Newman, senior wealth adviser at Newman Group, a ScotiaMcLeod affiliate. "Eventually we're going to have to see a handoff to topline growth."

Investors have long questioned the sustainability of margin-driven earnings growth. Not concerned enough, evidently, to reduce their U.S. stock exposure.

Growing tensions between the West and Russia didn't dissuade investors, either.

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"The apathy is notable and we question whether investor paralysis is setting in – an environment where investors don't want to chase but are not quite ready to sell either," Michael O'Rourke, chief market strategist at brokerage firm JonesTrading, said in a note.

For investors, a lack of alternatives keeps them beholden to the stock market, Mr. Newman said.

"Stocks may no longer be cheap. But a basket full of dividend stocks paying 3 per cent to 4 per cent with dividend growth and the prospect of capital appreciation is a whole lot more attractive to me than a 10-year Government of Canada bond paying around 2.1 per cent."`While this earnings season is shaping up to be a good one, much of the earnings upside over the next year may already be priced into stocks, Mr. Buchanan said.

"We're not negative on stocks, but we do think the recent runup has borrowed from future potential."

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