Last week we highlighted the continuing decline in Wall Street analysts’ expectations for first half 2019 corporate earnings. The upshot of our findings was that numbers are coming down at a faster-than-usual rate. Why this matters: 1H 2019 is shaping up to be a very slow-growth period for S&P 500 earnings, putting the possibility of an “earnings recession” on investor’s radar screens.
Today we have a 3-point update on these numbers, with data courtesy of FactSet’s weekly Earnings Insight report (link at the end of this section):
#1: Even with 22% of the S&P 500 having reported so far with an average of a 3% beat to Q4 2018 earnings expectations, numbers are still coming down for Q1 2019. Here is the progression of Q1 revenue and earnings expectations since the start of 2019:
- On January 4th, analysts had 2.9% earnings growth/7.3% revenue growth baked into their Q1 2019 numbers.
- On January 11th, that fell to 1.8% earnings growth/6.2% revenue growth
- On January 18th, they declined further to 1.1% earnings growth/still 6.2% revenue growth
- Now, expectations are for 0.7% earnings growth/6.1% revenue growth
Key takeaway: Q1 2019 is shaping up to be a no-growth quarter for US corporate earnings. The problem is NOT revenues (expectations there are still +6%), but rather margins. While that’s an understandable trend this late in an economic cycle, negative earnings leverage is never an investment positive.
#2: The story is much the same for Q2 2019 numbers.
- At the start of 2019 (January 4th) analysts were looking for 2.9% earnings growth/7.3% revenue growth for Q2.
- Those expectations have now declined to 2.4% earnings growth/5.3% revenue growth.
- Importantly, revenue growth expectations for Q2 2019 (that 5.3%) are below Q1’s (6.1%) and this trend continues into Q3 2019 with analysts’ revenue estimates of 5.0%. Analysts are still holding out hope for Q4 2019 to show +6% sales growth.
Key takeaway: while Q2 2019 earnings growth may end up being an improvement from Q1’s run rate, both sit at essentially 0% – 2%. The issue here is not revenues, so we cannot blame the US government shutdown or slowing global growth. Rather, we’re looking at a margin problem which analysts expect to extend through the first half.
#3: The important issue for US equity market direction is this: how much are investors willing to “look through” a soft first half for corporate earnings?The old aphorism that “markets predict conditions 6 months out” is a useful one to consider this question. Specifically:
- Fed Funds Futures currently predict the US central bank will not be moving interest rates in the back half of 2019. The odds that rates stay the same as now (2.25% to 2.50%) are 72% for July’s meeting and 66% for December’s meeting. The odds of a 2H 2019 Fed Funds bump is just 26%, looking at the December contract.
- While US/China trade negotiations may slip past the current March 1st deadline, market sentiment is that the two will come to some agreement in the first half of the year. Assuming this would reinvigorate global growth, 2H 2019 earnings estimates (Q3: 3.1%, Q4: 11.1%) would have a better chance for upside revisions.
- While widely-watched recession indicators like the 2-10 year Treasury spread have been flashing some concern, they have not yet turned to red from yellow. The difference between 2s and 10s sits at 14.7 basis points, stable for the year and slightly better than the 11-12 bp readings during December’s darkest days.
Our summary point on all this: US earnings fundamentals for 1H 2019 are decidedly lackluster, so a bullish position on equities comes down to believing the Fed stands pat and US/China negotiations are done by May/June. Both are logical assumptions, and both would support the belief that 2H earnings growth will improve. At the same time, we worry that that investors will occasionally (and perhaps violently) fret over the current weak state of earnings growth. Over the years we have learned that growth rates around zero (as 1H earnings look to be) create nonlinear market responses. And that’s exactly the setup we have in US stocks just now.
FactSet Earnings Insight Report: https://www.factset.com/hubfs/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_012519.pdf