Will US earnings raise the bar?

After primarily focusing on trade tensions and central bank activity since early May, market participants are set to switch attention to company fundamentals as the second-quarter (Q2) earnings season kicks off in the US.

The next few weeks should reveal just how well companies are coping with the heightened trade tensions and slowing global growth. The key element to watch for, as always, will be management guidance on earnings expectations. And there, the picture may not be that encouraging.

Low earnings bar set

We believe that, just like in the first quarter, the expectations bar is low and the majority of companies should deliver results that beat consensus expectations. The reported 25% earnings growth seen in Q2 2018 sets tough comparable performance numbers for companies.

Management expectations for Q2 have been lowered accordingly, with almost four negative pre-announcements for every positive one. As a result, we pencil in low-to-mid single digit earnings growth compared with ‘bottom-up’ consensus models indicating 0%. As always, share buybacks by companies will be an important contributor to earnings and are likely to add around 2% to earnings per share (EPS) growth for the quarter.

Forward guidance may disappoint

We are less optimistic with regards to forward-looking statements for the rest of 2019. In normal times, with two quarters passed, companies can firm up full-year guidance. Yet, because uncertainty is so high, we believe there are very few incentives for management to release an upbeat message.

The manufacturing sector, where trade tensions remain problematic, in particular will find it difficult to be upbeat. However, analysts have already cut their 2019 forecasts, leading earnings growth expectations to slide to just 2.2% from 3.3% back in April (and 7.3% at the beginning of the year) for the S&P 500.

Market to remain range-bound

All in all, we expect 2019 consensus numbers to be left largely unchanged, while 2020 numbers could come under some pressure. As the consensus EPS level for 2020 was lowered proportionally to 2019’s downward revisions, earnings growth is still expected to reach 11.5% in 2020, unchanged year-to-date. This should support equity valuations around current levels.

In this context, the market is likely to remain stuck in a range for much of this year. This does not mean that buying opportunities don’t exist. But opportunities are more likely to be found at the sector/stock level rather than at the index level, supporting our preference for active management. From a style perspective, we continue to favour quality, growth and yield enhancing strategies.

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