This week starts a deluge of company reports as the fourth quarter earnings season opens up for S&P 500 members. Analysts are forecasting overall profits to grow about 15 percent year-on-year in Q4 with some sectors, like energy and industrials, exceeding that.
Much, but not all, of this is due to the sugar rush from President Trump’s tax cuts, which propelled earnings growth towards 25 percent in recent quarters. That sugar rush is starting to fade and a key question is how quickly such growth falls away in 2019.
Our expectation is that company profits will stabilize around mid-single digits. This would be a necessary if not sufficient condition for equity markets to make progress this year.
Management guidance will be important in helping us understand any slowdown and how companies are dealing with a number of challenges like trade tensions, heightened regulation, disruptive technology, supply chain changes.
Equity markets entered this year in a particularly bearish mood and have since regained some ground on hopes that the Fed will be more cautious and Presidents Xi and Trump more amicable. The next few weeks should help us judge whether that rally is warranted, can become extended or whether markets are being overly optimistic.
One of the biggest questions is exactly how U.S. companies are being impacted by the trade war, especially its effect on the Chinese economy. The revisions to Apple’s guidance have been taken as a general sign that it is beginning to feedback back to U.S. companies, although fundamental changes to the smartphone cycle also mattered.
In truth, the revisions did not come as a big surprise. We have seen plenty of evidence on the ground in Asia from Apple’s supply chain that pointed to lower-than-expected iPhone production and the company confirmed that the trade war was only partly to blame. Still, the extent to which the trade war is coming back to bite broader parts of corporate America should become clearer during this earnings season.
The S&P 500 conference calls will also help build a better picture of how the U.S. economy is faring, which in turn will influence the Federal Reserve’s understanding of the direction of policy making. The Fed has clearly indicated that it is much more in listening mode, wary of the impact of the tightening of financial conditions. Hence equity and indeed bond markets will be eagerly extrapolating from management guidance to try and build a better picture of which way the Fed will turn.
Margin compression is a particularly important topic. There are a number of moving parts: sales growth may be holding up well, but there are pressures from mounting labor costs while regulation plays a part in some sectors. These are offset however by a helpful improvement in productivity growth even this late in the cycle.
This will not be a stellar earning season. But it will be an influential one. The best of the gains of the Trump tax cuts are behind us and the outlook for companies is fogged by a number of big uncertainties. The risk is that firms use the recent selloff to lower the bar for next year, which would be worrying. There is sufficient momentum to deliver decent profits growth for the time being, and when investor sentiment has been so depressed even a modicum of good news can encourage risk-averse investors to put cash to work.