Fears of a looming U.S. recession have subsided, with investors taking comfort that the Federal Reserve will continue to support economic growth.
But warning signs keep flashing about the shaky fundamentals of the economy and, therefore, the stock market. The latest alarm bell is that Wall Street analysts are slicing their forecasts for how much big companies will earn in the months ahead.
Halfway through the first quarter of the year, analysts now expect profits of companies in the S&P 500 to decline by 1.7 per cent from the same period in 2018, according to data from John Butters, senior earnings analyst at FactSet.
That is a sharp reversal from the start of 2019, when the same analysts predicted that corporate earnings would rise by 3.3 per cent compared with the first quarter of 2018. And in October, before the stock markets entered a downward spiral at the end of the year, analysts had anticipated that first-quarter earnings would leap by 6.6 per cent.
Corporate profits are by no means a perfect proxy for the health of the U.S. economy, the world’s largest. But they exert heavy influence over the direction of the stock markets.
In the first nine months of 2018, for example, an unexpected gusher of company earnings – up 20 per cent from their previous levels – powered the S&P 500 to record highs. The fat bottom lines allowed investors to look past both the prospect of a trade war between the United States and China and a number of data points that showed large foreign economies, including Japan and Germany, losing steam.
Even in the final three months of 2018, as the United States appeared to be skidding into an economic recession, corporate profits leapt higher. Not all companies have disclosed their fourth-quarter results yet, but they are on track to be up 13.3 per cent from 2017.
It isn’t unusual for analysts to pare back their earnings forecasts over the course of a quarter. Corporate executives offer guidance about how their businesses are performing, and a variety of macroeconomic data helps analysts hone their profit projections. During the past decade, analysts’ profit forecasts have declined on average by 3.7 per cent over the course of a full quarter.
On Dec. 31, analysts expected companies in the S&P 500 to earn, on average, $40.21 per share. Today, that estimate is $37.95 – an unusually large 5.6 per cent drop, according to FactSet.
If companies’ first-quarter performances turn out to be as weak as analysts expect, the United States will be on track for what the financial community calls an earnings recession, which occurs when corporate profits shrink for two straight quarters.
That looks increasingly likely to happen in the first half of this year. Analysts expect earnings to rise by just 1.2 per cent in the second quarter. That forecast is likely to fall, perhaps into negative territory, as more companies disclose their results and analysts update their forecasting models.
The S&P 500 last endured an earnings recession in 2015 and 2016. It was set off in large part by tumbling oil prices, which eroded the profits of energy companies. During that period, a six-year stock market rally stalled, and the S&P 500 twice fell by more than 10 per cent.
Corporate profits this year were always going to face a difficult comparison with 2018. The combination of a strong U.S. economy and the newly reduced corporate tax rates led earnings to jump more than 20 per cent.
But profits are now under pressure on multiple fronts, and there are no new tax cuts to cushion the blow – an ill omen for the stock market, if not the broader economy. Rising costs and a slowing global economy, in particular in China, have caused many S&P 500 companies to reduce their profit outlooks for 2019.
That is especially true among technology companies. Analysts expect them to report a nearly 10 per cent decline in profits in the first quarter, the biggest decline of any sector in the S&P 500.
Much of the blame for the tech sector’s declining fortunes rests with Apple. The company warned in early January that it was seeing diminished demand for new iPhones in China. When it reported earnings, Apple said it expected sales of $55 billion to $59 billion in the current quarter, below analysts’ expectations for $59 billion.
Since the end of 2018, analysts have cut by nearly 19 per cent their estimates for how much Apple will earn in the first three months of the year.