Skip to main content
investor newsletter

As Wall Street braces for the first quarterly decline in earnings in nearly three years, some investors are wondering if the market is factoring in a bigger erosion in profit margins than will actually come to pass.

Forecasts for U.S. earnings, after a big boost from corporate tax cuts in 2018, are falling sharply in 2019. But revenue forecasts remain relatively robust, leaving an expected spike in costs as the main reason for profitability to weaken.

But some strategists say there is little evidence yet of such cost pressures and that margins may hold up better than expected.

“Companies since the 2008 trauma have made it a top priority to maintain and increase, if possible, their profit margins,” said Ed Yardeni, president and chief investment strategist of Yardeni Research.

“We don’t expect that labor compensation and other costs will squeeze margins. Nor do we expect that an increase in those costs will boost prices,” he added. “Rather, we are betting on improving productivity.”

Besides the tightening labor market, the trade war between the United States and China and the stronger U.S. dollar are among the biggest potential risks to corporate margins this year.

For the first quarter, analysts are forecasting a year-over-year S&P 500 earnings decline of 0.5 per cent, according to IBES data from Refinitiv. Second-quarter earnings are still expected to grow 3.5 per cent, though that estimate also is down sharply from the start of the year.

The drop in forecasts has led to talk of a profit recession, defined as at least two consecutive quarters of year-over-year earnings declines. The last U.S. profit recession ran from July 2015 through June of 2016.

Projected revenue for S&P 500 companies has been more resilient, with first-quarter revenue growth estimated at 5.3 per cent, based on Refinitiv’s data.

Credit Suisse strategists said profit margins are holding up better than the estimates suggest, at least for the majority of S&P 500 companies.

They said profit margins are eroding sharply for several heavily weighted companies, including Apple, Exxon Mobil and chipmakers like Micron Technology, which are skewing data for the entire S&P benchmark index.

A recent drop in oil prices has hurt margins for energy companies, a slowdown in the semiconductor business cycle has hit companies in that space and other firms have boosted investment expenses, said Patrick Palfrey, senior equity strategist at Credit Suisse Securities in New York.

“It’s not a broad-based macro issue,” he said. “When you look at the median company, we see margins quite stable.”

Moreover, worries that a tight labor market will drive up wages have been limited in earnings calls for the fourth-quarter reporting period, which is nearing an end.

Goldman Sachs strategists wrote in a note on Wednesday that while some companies are feeling the pressures of rising wages, more consumer-facing companies, including Discover Financial Services, viewed the trend as a positive for consumer spending.

Also, they wrote, most management teams “expected growth in the U.S. economy to moderate, but remain positive.”

While the labor market has been tightening, other measures of inflation have not moved much. In the 12 months through January, the U.S. consumer price index rose 1.6 per cent, the smallest gain since June, 2017, according to U.S. data released on Wednesday.

Though slower than 2018, U.S. economic growth was forecast to average 2.4 per cent this year, according to a Reuters poll of economists.

“When the overall economy is relatively strong, that typically means there’s still sufficient demand for products and it helps stabilize margins in general,” said Keith Lerner, chief market strategist at SunTrust Advisory Services in Atlanta, Georgia.

-Caroline Valetkevitch of Reuters

This is the Globe Investor newsletter, published three times each week. If someone has forwarded this e-mail newsletter to you or you’re reading this on the web, you can sign up for the newsletter and others on our newsletter signup page.

Stocks to ponder

Sierra Wireless There are only two technically attractive, oversold index members by RSI this week – Sierra Wireless Inc. and SNC-Lavalin Group Inc. But Relative Strength Index buy signals have had a mixed record in identifying profitable entry points for Sierra Wireless stock in the past 36 months. Scott Barlow reports.

The Rundown

The brief, shining moment of rising rates for savers and conservative investors is over

Will nothing save Canada’s savers from low-interest-rate purgatory? Just six months ago, returns on guaranteed investment certificates and high-rate savings accounts were edging higher and there was a sense of more to come. Then came the Big Fizzle. So what are we left with? Rob Carrick surveys the landscape. (for everyone)

How a top investor and author manages his portfolio

William Bernstein is a retired neurologist who educated himself about investing in the early 1990s. As anyone with scientific training would do, he surveyed the scholarly literature, collected data and built models. Thinking his findings would be of benefit to others, he wrote a book called The Intelligent Asset Allocator (2000), followed by The Four Pillars of Investing (2002) and several other books. His writings can also be found at efficientfrontier.com. Larry MacDonald takes a look at his strategies. (for subscribers)

Income-hungry investors should consider this often-overlooked corner of the preferred share market

Falling interest rates in the early part of 2019 mean investors are going to have to work harder to meet their needs for income. Suggestion: Take a look at perpetual preferred shares. Perpetuals pay a set dividend and that’s about it. There’s no redemption date in most cases and, unlike rate-reset preferreds, there is no resetting of the dividend every five years to adjust for changes in interest rates. Read more from Rob Carrick (for subscribers)

Oil price risks have shifted to the upside

Oil traders no longer expect the market to be oversupplied this year, amid optimism a full-blown U.S.-China trade war will be averted, and oil production growth will slow thanks to OPEC cuts and sanctions on Venezuela. John Kemp of Reuters takes a look at what it means for energy investors. (for subscribers)

Others (for subscribers)

The diversifiers: lesser-known companies with growing earnings

Momentum stocks: These six U.S. large caps could be set for further gains

TSX Composite earnings scorecard: How fourth-quarter results have fared

Berkshire trims Apple stake, adds Suncor and Red Hat, exits Oracle

Berkshire Hathaway’s Charlie Munger targets active managers, Elon Musk; praises China

Others (for everyone)

The top 10 questions people ask about RRSPs

The top 10 Canadian equity analysts of 2018 – and their most profitable picks

Ask Globe Investor

Do you have a question for Globe Investor? Send it our way via this form. Questions and answers will be edited for length.

What’s up in the days ahead

ETF investors may be overlooking a better way to play the cannabis sector. Matt Lundy will explain next week. And, David Berman has a stock pick for those hoping to invest in the trend towards a cashless society.

Click here to see the Globe Investor earnings and economic news calendar.

More Globe Investor coverage

For more Globe Investor stories, follow us on Twitter @globeinvestor

Click here share your view of our newsletter and give us your suggestions.

You may also be interested in our Market Update or Carrick on Money newsletters. Explore them on our newsletter signup page.

Compiled by Gillian Livingston and Darcy Keith

Follow related authors and topics

Authors and topics you follow will be added to your personal news feed in Following.

Interact with The Globe