Traders work on the floor at the New York Stock Exchange, June 5, 2019.
Brendan McDermid | Reuters
Tuesday marks the halfway mark — more than half of the S&P 500 has reported second half earnings.
The good news:
1) Second quarter earnings are providing few surprises — earnings are beating estimates by the usual percentages (76% of those reporting are beating, about in-line with the last four quarters), and…
2) Earnings guidance for the second half of the year is not collapsing as some feared they might. The slower global economy, and the related tariff and trade war, is proving a drag on many corporations that get significant revenues overseas, but earnings guidance overall for the second half is not collapsing and can best be described as “flattish.”
3) Dovish central banks (including the Federal Reserve) are providing a backstop to corporate earnings and slower global growth.
The bad news:
1) Stocks are pricey and there is very little room for missteps, and
2) Clarity on global growth, including tariffs and trades, is very elusive.
Earnings are expected to be up a modest 0.9% for the second quarter, according to Refinitiv, reinforcing the widely held view that, after a 23% run-up in earnings in 2018 fueled by tax cuts, earnings in 2019 will be essentially flat:
Q1: (actual) up 1.6%
Q2 (est.): up 0.9%
Q3: (est.): down 0.7%
Q4: (est.): up 5.7%
Goldman Sachs reflected this view today: They cut their 2019 earnings estimate for the S&P 500 to 3% growth, from a prior estimate of 3%-6% growth.
Given the margin of error, that is essentially “flattish.”
That is a great comfort to bulls, who were fearful of a cascade of downward earnings revisions from multinational companies under assault by trade wars and slower global growth would lead to a dramatic earnings “recession.”
However, while there is no earnings collapse, the trade wars and slower global growth are clearly having an impact. More than half of companies with significant revenue exposure overseas are seeing declines in earnings growth, but companies with more domestic oriented focus that get the majority of revenues inside the United States are seeing modest increases in earnings:
Q2 earnings: domestic vs. foreign sales
>50% of sales outside U.S. down 9.7%
<50% of sales outside U.S. up 6.4%
Put it all together, and it balances out to “flattish” earnings.
While the most dire warnings of the bears have not come to pass, they do have a point: Stocks are pricey and there is very little room for missteps. It’s tough to be bullish when the S&P is up 20% for the year, earnings are flat, and there is so little clarity on global growth.
What makes it easier for the bulls to stay bullish are the direction of interest rates. The markets are becoming more dependent on the belief that dovish central banks will provide a backstop to slower global growth — and they do have history on their side. In a recent note, DataTrek noted that earnings for 2014 to 2016 were essentially flat, but the S&P was up 28% during that period, thanks to lower long-term interest rates.
Bulls are again assuming that the global central bank backstop will keep the global economy out of a recession. But that is an assumption, not a fact of history: it’s not clear that global central bank magic will always work.
If not, and the global growth picture does not improve, earnings guidance will come down dramatically.