Plunging stock prices and valuations already have badly rattled investors, and it's likely to get worse if earnings forecasts are any indication. In December, analysts cut their 2019 earnings forecasts on more than half of the companies in the S&P 500 Index (SPX), according to data compiled by FactSet Research Systems. This is the first time in two years that such an extensive downgrading of profit projections has occurred, according to The Wall Street Journal.
Significance For Investors
Stock prices are under pressure from anticipated interest rate hikes by the Federal Reserve and lingering concerns about the negative economic effects of America's escalating trade conflict with China led by President Trump. These two factors are among several headwinds that could lead to a so-called earnings recession.
“An earnings recession isn’t a sure thing...but if these key [economic] indicators stay on their current path, it may be hard for stocks to avoid that conclusion,” observes Jeffrey Kleintop, chief global investment strategist at Charles Schwab, per the Journal. As defined by S&P Dow Jones Indices, an earnings recession usually occurs when S&P 500 earnings per share decline for two quarters from the same period a year earlier.
Propelled by economic growth and corporate tax cuts, S&P 500 earnings are projected to post a 22% year over year (YOY) growth rate in 2018, per the same sources. Profit growth in 2019 was forecast to be 10.1% at the end of last September. The latest estimates have brought that figure down to 7.8%.
The most recent release of the monthly Global Fund Manager Survey conducted by Bank of America Merrill Lynch indicates that leading global investment managers are the most pessimistic about the corporate profit outlook since the 2008 financial crisis, per the Journal. The principal factors that they believe will depress profits are rising wages, increased costs of imported materials (partly due to tariffs), and slowing economic growth outside the U.S. Additionally, corporate tax cuts in the U.S. boosted profits in 2018 versus 2017, but aren't expected to deliver growth in 2019 versus 2018.
Many market analysts are equally pessimistic. "The global economy is already on an irreversible path to an economic downturn," Naka Matsuzawa, chief rates strategist at Japan-based Nomura Securities, writes in a report cited by Business Insider. He bases this conclusion on his analysis of the global credit cycle. Noting that the cycle typically lasts about 10 years, Matsuzawa finds that it is nearly at a peak right now, to be followed by a contraction and economic recession.
Meanwhile, the price of oil is sending mixed signals. While a recent decline in oil prices bodes well for profits outside the energy sector, by reducing the costs of energy inputs, it also may be "more of a prediction for a global economic slowdown [than] simply a supply and demand imbalance," per Sam Stovall, chief investment strategist at CFRA Research, as quoted by the Journal. "Oil is adding to the agita associated with earnings," Stovall says.
If the global economy does indeed falter, and corporate earnings with it, it is pretty much inevitable that stock prices will follow downwards. Among the big milestones in the first quarter of 2019 will be early March, a deadline set by President Trump for reaching a trade deal with China. Depending on how the negotiations progress, that date might see either a relaxation in trade tensions, or the imposition of new tariffs by Trump that will raise costs for U.S. businesses and consumers. That would further dim the outlook for corporate profits and the economy alike.