Enjoy your Fourth of July barbecue because corporate earnings are poised to give the market indigestion.
While it’s not the way most people would chose to return to work after a long holiday weekend, next Monday marks the start of second-quarter reporting season. Wall Street is bracing for yet another period of near-zero profit and sales growth — but only because a record number of companies have slashed their outlooks ahead of earnings.
The good news is that, in the aggregate, companies in the S&P 500 are forecast to post their third consecutive quarter of earnings growth. The bad news is that Wall Street expects earnings to increase by only 0.8%, according to data from FactSet. Revenue also is expected to advance, but by a paltry 1.2%.
The usual suspects are to blame. Weak demand from China has hurt everything from demand for industrial components to commodities prices. And when China sneezes, all the other emerging markets catch cold, further depressing global demand.
At the same time, Europe remains in recession, which adds to the desultory demand picture. Oh, and the dollar is stronger relative to other currencies, which makes U.S. exports more expensive overseas.
More than a third of S&P 500 revenue comes from international markets, and this across-the-globe weakness hasn’t been doing U.S. multinationals any favors.
It also doesn’t help that, although the U.S. economy is reasonably robust compared with most of the rest of the developed world, it’s hardly running at full capacity. We don’t have official estimates yet for the most recent quarter, but we did learn last week that first-quarter gross domestic product expanded at only a 1.8% rate — well below the prior estimate of 2.4%.
Bottom line: Corporate earnings are the ultimate driver of stock prices and many of the engines of corporate profits are sputtering. No wonder companies have been cutting guidance like mad ahead of earnings season.
As of June 28, 87 companies in the benchmark index had reduced profit estimates for the upcoming reporting period, according to FactSet. That’s a record, and the previous one of 86 earnings warnings was set in the first quarter of 2013.
Indeed, of the total number of companies issuing updated guidance — whether positive or negative — a record 77% of them marked down their profit forecasts.
Sure, all the anxious chatter about the Federal Reserve pulling back on its bond-buying program is contributing to volatility, but Tobias Lefkovich, chief U.S. equity strategist at Citigroup, wrote in a recent note to clients that the earnings warnings bloodbath is a contributing factor too — even if it’s gone largely unnoticed:
“We have been a tad shocked by the surge in negative-to-positive preannouncement trends that make 2009’s surge appear less worrisome in retrospect. Upward earnings guidance has dipped as well and there has been little consternation or discussion about it.”
True, not all sectors are created equal when it comes to what we can expect from second-quarter results. Financials are forecast to have the highest earnings growth rate in the S&P 500 for the second straight quarter, posting a 17% gain. On the other end, slumping commodities prices will contribute to a 7% decline in earnings in the materials sector — the worst showing in the S&P 500.
Here’s a sector breakdown for projected Q2 earnings growth rates, courtesy of FactSet:
As was the case in the first quarter (which everyone knew would be bad), the market continues to stay aloft on expectations for a second-half acceleration in earnings, if not sales. But even there, the optimism is fading.
Analysts, on average, project third-quarter earnings to increase 7.3%, down from 9.9% a few months ago, while fourth-quarter earnings are forecast to grow 13.1%, down from a prior projection of 14.3%.
It would be really helpful if something came along to arrest that slide. Global economic weakness and a less dovish Fed haven’t corralled the bulls yet, but it’s hard to see how some serious second-half disappointments wouldn’t cause them at least to stumble.