When earnings season kicks off unofficially early next week, investors will focus on what companies expect for this year amid hopes that rising profits will provide the foundation for the stock market’s next rally.
Corporate executives will be under pressure to persuade Wall Street that U.S. businesses will see no more than a modest slowdown in earnings growth from their stellar pace last year—a tall order as trade tensions and the Federal Reserve’s rate increases create potential profit headwinds. That’s based on a note from Nicholas Colas, co-founder of DataTrek Research, who says as long as companies manage that tricky feat, U.S. equities should rally this year.
“Companies must convince investors that 2019 will show further earnings growth even as profit margins actually decline,” wrote Colas in a Monday research report.
Investors might be forgiven for dismissing earnings season as a big catalyst for equity markets. At the latter end of last year, Wall Street shook off a raft of stronger-than-expected earnings results, in part because fears of an impending recession and worries that earnings results in the future couldn’t get any better.
A Federal Reserve that was viewed as being overly ambitious in its attempt to normalize rates from crisis-era policy also was seen as a point of friction for investors, perhaps, amplified by dread that the U.S.-China trade spat would help to further gum up global economic expansion.
Still, Colas says earnings guidance will prove crucial, as it may offer companies the opportunity to beat back downcast expectations in the aftermath of the sharp selloff last Thursday, sparked by Apple Inc.’s AAPL, +0.41% cut to its sales forecasts, which was blamed on Washington’s dust-up with Beijing.
The S&P 500 SPX, +0.70% and Dow Jones Industrial Average DJIA, +0.42% are both tentatively higher at the year’s start, but that comes after a disastrous month resulted in both benchmarks producing their worst Decembers since 1931.
Equity strategists have cut their expectations for earnings-per-share, or EPS, growth for the S&P 500 but those Q4 estimates remain high, for 11.4% growth, down from 16.4% at the start of the fourth quarter, according to FactSet data.
More important, EPS for the broad-based index in 2019 overall is now expected to climb by 7.4% to $173.45 a share, from a more optimistic forecast of 10.2% three months ago.
That means if the S&P 500 remains at its Friday close of 2,532 and earnings estimates in 2019 pan out accurately, the index should trade at multiple of 14.6 times earnings in 2019. But if earnings fail to grow altogether, the index would trade at a price-earnings multiple, a popular way of valuing stocks, of 15.6 times earnings in 2019. To be sure, that would mark a substantial drop from around 20 times 12-month trailing earnings at the start of the year.
Assuming earnings growth remains balanced between current expectations and those in which earnings growth grinds to a halt, stocks should still remain a buying opportunity, said Colas.
But there is no certainty that results will hearten the market, Colas cautions.
“Declining margins and a possibly zero-growth Q1 are fundamental headwinds, as is the continued uncertainty over U.S./China trade. We are not, in other words, out of the woods just yet,” he said.
Next Monday, Citigroup C, +0.87% will unofficially launch earnings season, with peer lenders JPMorgan Chase & Co. JPM, +0.07% and Wells Fargo & Co.WFC, -0.65% set to roll out quarterly results on Jan. 15.
