Trade conflicts and slowing economic growth are weighing on S&P 500 earnings, which are expected to be down on a year over year basis in 3Q 2019, for the third consecutive quarter of declines. Market watchers and investment strategists advise investors to pay close attention to 5 key trends behind this downward trajectory, including the impact of higher input and labor costs on profit margins, anticipated weak performance by the big banks, the effect of the trade war on tech stocks, how consumer spending is holding up, and the direction of corporate guidance over the next year, the Financial Times reports.

Data compiled by FactSet Research Systems and reported by the FT are not encouraging. The average net profit margin for all S&P 500 companies is projected to be 11.3% in 3Q 2019, versus 12.1% in the same period of 2018. Bank revenues and earnings are projected to be down by 1.6% and 1.8%, respectively, YOY. For tech stocks, earnings are expected to drop by 10% YOY, as revenues increase by a scant 0.3%.

Key Takeaways

  • S&P earnings are projected to be down YOY in 3Q 2019.
  • This would be the third straight quarter of declines.
  • Rising costs, trade conflicts, and a rising dollar are hurting profits.
  • Consumer spending has been strong, but may weaken.
  • Bank profits are crimped by falling interest rates.
  • But history indicates that the estimates may be too pessimistic.

Significance For Investors

Goldman Sachs estimates that wages will be up by 3.2% YOY in 3Q 2019, per the FT. Meanwhile, the U.S. dollar rose in value by about 3.4% in the quarter, which will reduce the dollar value of revenues and profits booked abroad by U.S. companies. As a group, the S&P 500 companies derive more than 40% of their sales from outside the U.S.

Falling interest rates, as the result of rate cuts by the Federal Reserve, are reducing banks' net interest margins. Meanwhile, the U.S.-China trade war is a major problem for tech firms. “The biggest worry from investors continues to be the China black cloud which is casting a long shadow over semiconductor and tech names, including Apple [Inc. (AAPL)], across the board,” as Dan Ives, an analyst at Wedbush Securities, told the FT.

Consumer spending, which accounts for about 68% of U.S. GDP, has been among the bright spots recently, bolstered by wage increases and an unemployment rate that has fallen to a 50-year low. Despite an uptick in some recent surveys, consumer sentiment overall appears to be turning more cautious, Additionally, large and rising numbers of consumers are having problems paying their bills, encountering credit problems, or building up excessive amounts of debt, a quarterly survey by UBS finds.

A key measure of companies' growing caution is their unwillingness to make longterm forecasts. Before the financial crisis of 2008, roughly one in eight of the S&P 500 companies offered guidance about their next fiscal year during their 3Q earnings calls, the FT indicates. Since then, the number of companies who choose to offer such projections has dropped in half. Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America Merrill Lynch, tells the FT that the number is likely to be "significantly lower" this time, as companies become increasingly uncertain about the future.

Looking Ahead

Over the past 5 years, actual earnings have beaten consensus estimates by an average of 4.9%, according to analysis by FactSet reported by The Wall Street Journal. Given that the current consensus calls for a 4.5% decline in S&P 500 profits YOY, a slight increase in earnings is a distinct possibility. In 2Q 2019, actual earnings were down by only 0.1%, despite a consensus forecast of a 2.7% drop going into the reporting season.

In a current report, BofAML projects that actual 3Q 2019 EPS for the S&P 500 will come in at about 2% below their year-ago level. During the first week of earnings reports for 3Q 2019, they find that the proportion of companies beating estimates of both EPS and sales is in line with historical averages, while beats of earnings alone are trending well above the averages.

Nonetheless, BofA's Subramanian warns that consensus forecasts for future periods are too optimistic in calling for YOY EPS growth of 3% in 4Q 2019 and 10% for full year 2020. “EPS declines are like cockroaches,” she told the FT, adding, “Rarely a one-quarter event.”