The start of earnings season for 2Q earnings has investors on edge. The data shows that analysts are expecting the largest earnings retrenchment in three years. Can the US continue to distance itself from the contagion of global slowing?
According to FactSet, more than 80 S&P 500 companies have already warned that their 2Q results will be lower than originally forecast. What’s interesting is that while revenue estimates have come down slightly over the last year (from 4.8% to 3.4%), earnings estimates have been impacted much more significantly (from 10.6% to -0.1%) based upon data from Refinitiv. In our view this suggests that costs are increasing and margins are being impacted — either as a result of tariffs, repositioning of supply chains, and/or higher labor and raw material input costs.
That is more than usual, analysts said, and puts the broad index at risk of facing its first period of two or more consecutive quarters of declining earnings since 2016.
Yet, earnings season tends to be a game of managing expectations, lowering hurdles and beating them with actual results (some would call it sandbagging) – Apple is said to be a master at this. And analysts tend to overshoot lower into the actual earnings. The first quarter of this year is a good example of this phenomenon – actual earnings growth contracted at just 0.3% rather than the 4.0% analysts were predicting immediately prior.
So far, results have come in ahead of expectations – of 24 companies that have reported, 20 of them have beaten estimates. Some are already talking about a positive 2Q earnings surprise and a knee-jerk market reaction higher. Not so fast. During the earnings reporting period, companies also tend to adjust their forecasts, for the coming quarter and for the balance of the year. With all the uncertainties, especially trade war and tariffs, would you blame them for being ultra-cautious looking forward with limited visibility? It’s analogous to what happens when you encounter fog on the roadway when you are driving. You slow down and proceed more carefully – in short, you are much more cautious.
And that cautiousness may erode investor confidence going forward, especially if the much vaunted second half earnings recovery that the market was fixated on earlier in the year gets put off until the 4th quarter. According to FactSet, this looks increasingly likely as 3Q earnings growth is now expected to be negative as well.
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