Why Second Quarter Earnings Aren't As Dismal As They Look

Despite widespread expectations of an imminent earnings recession starting in 2Q 2019, chief investment strategist Sam Stovall says corporate profits may turn out to be much healthier than they look, and may actually rise -- instead of falling by 1.7% as analysts currently estimate. "Actual EPS exceeded initial estimates in each of the last 29 quarters by an average of nearly four percentage points," Stovall writes in his latest Q2 Earnings Outlook for research firm CFRA.

Following an increase of 2.5% in 1Q 2019, the consensus estimate among analysts projects a 1.7% decline in 2Q operating EPS for the S&P 500 Index (SPX), per data compiled by S&P Capital IQ. "Should history repeat itself, however, the final tally of Q2 results will likely see EPS growth head back into the positive zone," Stovall observes.

The table below summarizes Stovall's observations.

Significance For Investors

The consensus estimates foresee year-over-year earnings declines in 7 of the 11 S&P 500 sectors, with the biggest drops coming in materials (-20.5%), real estate (-9.2%), and utilities (-6.8%). Next among the projected losers are energy (-4.5%), information technology (-4.4%), and consumer discretionary (-3.8%). The only sectors expected to register earnings increases are financials (+4.3%), health care (+2.0%), and industrials (+0.2%).

The consensus also calls for a decline of 0.2% in 3Q 2019 S&P 500 EPS. Despite these two consecutive quarters of projected earnings declines, analysts anticipate an increase of 1.8% for full year 2019, followed by an even bigger jump of 11.6% in 2020. In his report, Stovall summarizes the views of CFRA's research analysts on the various S&P 500 sectors.

Regarding financial stocks, CFRA expects solid 2Q results for the biggest U.S. banks, driven by stable, fee-based businesses. The rising stock market should produce higher revenue and income for their asset management and wealth management divisions. Other positives are loan growth in both the consumer and commercial markets, strong M&A and IPO activity, and credit card fee income. Property and casualty insurers appear on track to produce an underwriting profit in 2Q 2019, largely the result of reduced catastrophe claims.

In health care, the FDA has been speeding up its approvals of new drugs and medical technologies. Meanwhile, the strong U.S. job market has increased enrollment in employer-sponsored health plans, and thus the earnings of the health insurance companies that provide coverage.

For industrials, rising tariffs are a headwind, but some companies have programs to produce operational efficiencies. Among transport companies, airlines enjoy strong business and leisure travel demand while raising fares. Despite recent deceleration in pricing and demand, truckers are still in a strong position, and logistics companies are seeing growth in the U.S., though tariffs and trade issues are weighing on international shippers.

Among the big projected losers are materials companies, according to the consensus. CFRA notes that materials companies are beset by "pressure on overseas economic growth, currency fluctuations, and higher raw materials and logistics prices." Regarding real estate, the report is upbeat on certain sectors. "Our 2019 fundamental outlook for the S&P Residential REITs index is steady rental growth with U.S. households finding it difficult to acquire homes due to higher selling prices," the report says.

Looking Ahead

Despite his measured optimism, Stovall hedges at the end of his report, conceding that an earnings recession is indeed possible. If 2Q earnings end up falling, Stovall says this may be an important sign of the start of an earnings recession. Should that happen, Stovall could end up joining skeptics such as Morgan Stanley, which has been perhaps the most prominent firm warning of such a decline.