How 2Q Guidance Could Hammer The Bull Market

Reporting season for 2Q 2019 is underway, and consensus estimates foresee a 3% year-over-year (YOY) aggregate profit decline for the S&P 500 Index (SPX), the biggest drop since 2Q 2016, according to data from FactSet. Adding to the gloom, 88 companies in the S&P 500, including some of the biggest, have warned that their 2Q 2019 profits will be weaker than previously anticipated.

Despite a decelerating global economy, and no end in sight to the U.S.-China trade conflict, the S&P 500 is hitting new record highs partly on expectations that the Federal Reserve will cut interest rates. Indeed, Fed Chair Jerome Powell hinted during testimony before Congress last week that a cut may come in July.

“Though few, if anyone, expected Powell to push back against the odds of a July cut, it’s still a bit surprising to see his testimony so weighted toward the negative, which suggests that the economy could be struggling even more than many investors had feared,” as J.J. Kinahan, chief market strategist at TD Ameritrade, told the Wall Street Journal. “The focus could be on whether corporate executives see some of the same concerns as Powell," he added.

Significance For Investors

While the median S&P 500 company is expected to report a 4% YOY earnings increase, some of the largest companies by market cap are projected to report declines, dragging the aggregate profit figure down, per Goldman's current U.S. Weekly Kickstart report.

The consensus anticipates that the aggregate S&P 500 profit margin will fall by 89 basis points, as a revenue increase of 5% is more than offset by rising costs, Goldman observes. Information technology is projected to be the hardest-hit sector, with EPS down by 10% YOY, per Goldman. This has wide implications, since tech stocks have been bull market leaders.

Moreover, 26 of the 88 profit warnings mentioned above, or 29.5%, are from tech companies. Analysis by Credit Suisse cited in the same article names these 10 big stocks as among those projected to report significant 2Q 2019 profit margin declines: Pfizer Inc. (PFE), -9.7%, Intel Corp. (INTC), -9.8%, Alphabet Inc. (GOOGL), -10.9%, Apple Inc. (AAPL), -14.7%, General Motors Co. (GM), -18.3%, Facebook Inc. (FB), -19.4%, Boeing Co. (BA), -28.6%, Micron Technology Inc.(MU), -30.9%, General Electric Co. (GE), -34.6 %, and Western Digital Corp. (WDC), -67.1%.

Apple, Alphabet, and Facebook are among the top 5 stocks by weight in the S&P 500, while Pfizer, Intel, and Boeing are in the top 28, per SlickCharts.com. Semiconductor manufacturers Intel and Micron are among those 26 tech companies that have issued negative guidance about 2Q 2019. “I think some of these tech stocks are up a lot, and if they miss because of margins, I think they’re very, very vulnerable,” as Andrew Slimmon, a senior portfolio manager with Morgan Stanley Investment Management, told the Journal.

Looking Ahead

Maybe deft corporate executives are once again managing expectations down, to create low hurdles. The 1Q 2019 reporting season began with the consensus calling for a 4% YOY S&P 500 EPS drop, but the actual decline was only 0.3%, per the Journal. Indeed, 20 of the first 24 S&P 500 companies to report beat estimates.

“Even though the stock market is at an all-time high, expectations about earnings is very low. That sets you up for a very good market response to earnings,” Andrew Slimmon says.