Headwinds Are Blowing
Trade and soft ISM readings for September were not the only earnings headwinds during the third quarter of 2019. In the third quarter, the U.S. dollar rose 3% year over year as compared with the year-ago quarter, which has weighed on earnings from international markets.
In addition, the average price of oil was down 19% compared with the year-ago quarter. Oil’s decline could be a significant drag on energy sector profits, which are expected to drop nearly 40% (Source: FactSet).
The flat yield curve, in which short-term and long-term interest rates are close together, creates a difficult environment for banks and could be a headwind for profit growth in the financials sector.
Technology sector profits are expected to drop on weakness in the semiconductor industry, which is caught up in the trade dispute.
Making Our Forecast
We lowered our 2019 S&P 500 earnings per share forecast back in August to $165 due to increased risk to economic growth and profits from the ongoing U.S.-China trade conflict. Until we have clarity on trade, we do not expect earnings growth to pick up meaningfully from current levels. We believe our 2019 earnings forecast is achievable, even if we see only as much as a temporary trade truce in the near term. If no tariffs are reduced or eliminated, and if additional tariffs go into effect on October 15 and December 15 as has been reported, then we expect to see several dollars’ worth of possible downside risk to S&P 500 earnings this year.
The complicated environment makes forecasting in 2020 very difficult. Our base case for S&P 500 earnings is $175 per share, representing a mid-single-digit increase from our 2019 estimate. That forecast is roughly $7 below the current consensus (Source: FactSet), which we expect to come down significantly over the next several quarters. In the absence of any progress on trade, earnings will likely stagnate near current levels. Escalation in the trade dispute could introduce $10 per share or more of downside risk to our 2020 forecast, although we place a lower probability on that scenario.
We maintain our year-end 2019 S&P 500 Index fair value target of 3,000, based on a price-to-earnings (P/E) ratio of just over 18 times our 2019 S&P 500 earnings per share forecast of $165. Next year, we expect S&P 500 earnings to increase to $175 per share. Couple that forecast with that same P/E, and we calculate the index could reach the range of 3,150 to 3,200 at the end of 2020. We believe mild inflation and low interest rates support these valuations.
John Lynch is chief investment strategist at LPL Financial.