Will Q3 earnings lift markets?
The third-quarter US earnings season is due to start on 15 October with large banks publishing their quarterly results. Companies face their toughest 2019 comparables this quarter, with growth of 29% seen in third-quarter 2018 courtesy of last year’s tax cuts (see chart). While we expect earnings to be slightly better than expected on average, we doubt this will be a strong enough catalyst to push markets higher.
Another low bar
Once again, bottom-up analysts’ expectations have been lowered going into the quarterly earnings publications.
The consensus expects S&P 500 earnings per share (EPS) to be down by as much as -4% versus last year. This number was still positive in July. Companies themselves have been busy talking down expectations. Of the 121 companies that have issued EPS guidance for the third quarter, 77 have issued negative EPS revisions.
Commodities under pressure
At the sector level, commodities-linked industries (energy at -30% and materials at -10%) face the largest contraction in earnings. With the average price of oil in the third quarter plunging by 19% year on year, this is hardly surprising.
More interestingly, technology is expected to see EPS drop by -8%. The weakness stems from semiconductors and semiconductor equipment (-30%) which have been affected by trade uncertainty and inventory adjustment. On the other hand, software (8%) and IT services (5%), two areas within the sector that we remain positive on, are likely to see growth.
Limited earnings contraction likely
Actual earnings reported by S&P 500 companies have exceeded estimated earnings by 4.9% on average over the past five years. Should this quarter follow a similar trend, earnings could actually see very modest growth. Buybacks and lower tax rates are likely to be large contributors to any such beats.
Expectations for 2020 likely to slip
While getting confirmation on how US corporates performed in the last three months is always valuable, the market will likely be more focused on companies’ guidance and outlook for 2020. Here, we expect a mixed message. Not only is the global economy showing signs of a slowdown, visibility on the geopolitical front remains elusive too. As such, we expect 2020 earnings growth expectations to gradually come down from the 10% currently anticipated.
Upside remains capped by trade uncertainty
With equities trading at a generous multiple already, any significant reduction in earnings growth forecasts would push valuations to levels that are unlikely to be sustained, without some hopes that a reacceleration is around the corner. Unfortunately, with central banks already easing monetary policy, the only two remaining catalysts we can think of are fiscal stimulus and trade peace.
Both potential catalysts seem unlikely at the moment. Indeed, a meaningful fiscal push, like the 2018 tax cuts, is improbable ahead of the 2020 US presidential election.
Similarly, a “mini deal” between China and the US may improve sentiment in the short term but not be enough to restore confidence and boost potential growth in the medium term. As such, we don’t expect this earnings season to be a game changer for equity markets.
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