US equities: lacking earnings upgrades

Earnings: good enough for now

More than half of US third-quarter (Q3) earnings have been published now. So far, results have been better than expected with more than 75% of companies beating bottom-line consensus expectations.

Sales have been more mixed. Just 60% of companies delivered better-than-expected growth, although this remains in line with historical averages. Results have not only exceeded forecasts, they have done so by a wide margin. Indeed, the average earnings beat was in excess of 4%.

On aggregate, S&P 500 companies are therefore on track to deliver broadly flat earnings growth this quarter. By contrast, expectations prior to the earnings season were for earnings to drop by 4% year on year.

While earnings growth may be low, it comes on the back of the most difficult comparable of the year, the third quarter of 2018 having seen significant tax cut-related growth. It also means that the US should avoid an earnings recession, something that investors worried about earlier this year.

Embedded pessimism helped

Another important characteristic of this earnings season has been the market’s reaction to earnings releases. Indeed, with the exception of some headline-grabbing plunges, company share prices have generally reacted well to Q3 earnings publications, even if these were below expectations. This is particularly true for the more cyclical parts of the market, where investors had discounted a significant slowdown.

Expectations for 2020 still too high

It’s not all perfect. Companies have provided limited colour on 2020, with many blaming the macroeconomic uncertainty for their silence. As a result, we’ve seen minor revisions to next year’s +10% earnings growth forecast.

The vast majority of investors, us included, believe the 10% growth number will come down. We pencil in just 6% earnings growth next year.

But with companies reluctant to guide the market, this means that markets are exposed to more drastic cuts later in the year or early 2020. This may prove to be a strong headwind to US equities, at a time when the S&P 500 is reaching all-time highs and valuations already looked stretched (on these ambitious numbers).

Expect heightened volatility to return

While investors have focused on company-specific developments for much of October, we expect macroeconomic considerations to come to the forefront in the coming weeks.

Although some progress has been made on key issues. including the US-China trade war and Brexit, none of them have been fully dealt with. As such, we believe that volatility is bound to increase into the end of the year.

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