Corporate results are one of the key indicators of economic growth. But, after consecutive quarters of near-record profit growth, companies are starting to lower expectations. With third-quarter earnings coming up in the next few weeks, US companies are cutting their outlooks at levels not seen since the first quarter of 2016. Almost 100 companies have offered guidance — 74 have provided a negative outlook, meaning they expect earnings to come in below Wall Street estimates, while just 24 have been positive, according to FactSet. The 76 percent negative-to-positive balance is above the long-term average of 71 percent. This is at a time where all the major indices are in near record territory.
Wall Street is almost all about expectations. Earnings growth in both the first and second quarters of 2018 was around 25 percent. Those growth rates, though, are expected to diminish considerably. The third quarter is projected to come in 19.3 percent while Q4 likely will slow to 17.3 percent, resulting in a full-year rate of a robust 20.4 percent, FactSet estimates. In 2019, those numbers deteriorate even further: 7.1 percent and 7.3 percent for the first two quarters, respectively, and a full-year rate of 10.3 percent.
With the market basing much of its prolonged rally in 2018 and 2019 on surging profits, a falloff could take the market the other way.
Future Wealth’s View
When investor sentiment is most positive is when it is time to step aside. In his book titled “Irrational Exuberance”, Robert Shiller argues that the term does not mean to suggest that few thousands of us go a little crazy during a bull market. He means that we all go collectively crazy during a bull market. Even those who have doubts about the bull market prices keep quiet about their doubts.
With third quarter likely to show the first real effects of the tariff wars, the impact of the U.S. tariff war with China will be a closely watched point for investors listening in to earnings calls. So, too, will be higher interest rates, inflation concerns and the general status of an economy that has been growing above trend since 2017.
Volatility in October tends to be higher historically. For longer-term investors, the investment implication is not to get spooked by October’s volatility. Chances are that it doesn’t represent the beginning of a new bear market. But, get ready for a wild ride.