By Michael Wursthorn
Corporate profits are proving to be more resilient than expected
in the second quarter, nudging the stock market higher this month
and distracting from anxieties about trade and economic growth.
Of the 221 S&P 500 companies that have reported earnings
through Friday, 170 have surprised investors with
better-than-expected results, according to FactSet. Technology
giants Alphabet Inc. and Twitter Inc. both topped expectations,
sending shares up 9.6% and 8.9%, respectively, on Friday. Coca-Cola
Co. and United Parcel Services Inc. also jumped after reporting
results last week.
Average earnings among S&P 500 companies that have reported
are up 0.7% from a year earlier, according to FactSet. That has
helped improve analysts' forecasts for earnings to a 2.6%
contraction for the quarter, better than the more than 3% pullback
they had been predicting last week.
"The notion of a widespread economic weakness seemed plausible
just a few weeks ago," said Ed Keon, chief investment strategist at
QMA LLC. "But in the last week or so you got a pretty good picture
of the earnings season, suggesting those fears are overblown. It's
a hopeful sign."
Earnings reports surprising to the upside are fairly common
because analysts tend to be conservative with their estimates.
Still, money managers say the latest round of results quelled some
of their concerns that corporate profits were rapidly shrinking
amid a faltering U.S. economy. More than 80 companies had warned
ahead of the reporting season that earnings could be weaker than
expected, helping to temper expectations, analysts said.
The S&P 500 has risen 2.9% so far in July, extending its
gain this year to 21%, largely driven by the expectation of an
interest-rate cut from the Federal Reserve. The stock market's two
best months, January and June, coincided with some of the strongest
signals from Chairman Jerome Powell that the central bank will cut
interest rates this year. Data from CME Group showed investors are
betting on a 100% probability that the Fed will cut rates at its
meeting this week.
Still, earnings gains in the latest quarter have done little to
lift investors' enthusiasm about where the stock market goes from
here. And for manufacturers like Caterpillar Inc., import tariffs
and trade tensions continue to weigh on outlooks. S&P 500
earnings are expected to rise just 1.7% over the full year,
compared with the more than 3% analysts had penciled in last
The muted earnings outlook for the remainder of the year has
contributed to a rise in pessimism among investors, analysts say.
The share of individuals who say they expect U.S. stocks to fall or
stay flat over the next six months has risen above those who are
more bullish on equities, according to the American Association of
Individual Investors' latest survey.
"The 'Powell put' is driving the market higher, but the problem
in the economy isn't that rates are too high," said Liz Ann
Sonders, chief investment strategist at Charles Schwab Corp. "What
ails us is a global manufacturing recession and business confidence
being severely dented by a trade war."
Industrial manufacturers are on pace to notch the second-biggest
contraction in quarterly profits after materials stocks, with
earnings projected to fall more than 12% from a year earlier,
compared with expectations of a less than 2% pullback earlier this
month, according to FactSet.
Caterpillar was a major contributor to that shift after the
maker of bulldozers and excavators missed analysts' earnings
estimates because of slowing machine sales in Asia and higher costs
from U.S. tariffs on Chinese imports. Shares of Caterpillar fell
more than 2% last week.
Meanwhile, technology and communication companies reporting so
far have mostly surprised investors to the upside, sending shares
of both sectors up more than 5% each this month. Excluding a
record-setting fine, Facebook topped analysts' expectations for
earnings and revenue, as did Google parent Alphabet.
But those latest gains have pushed stocks toward their richest
valuations of the year, alarming some investors who fear the market
doesn't have much juice left to climb higher in 2019 after the
S&P 500 posted its best first half of a year since 1997.
As of Friday, the S&P 500 traded at 17 times its earnings
over the next 12 months, its highest level since late September,
just before the stock market's fourth-quarter selloff. That is
above the 10-year average of nearly 15 times, according to FactSet,
but well below the valuations of the dot-com era.
Alan Adelman, a senior fund manager at Frost Investment Advisors
LLC, says current valuations include interest rates coming down and
expectations of a trade resolution between the U.S. and China. If
either of those don't pan out, stock prices will need to be
readjusted, he said. There is also some pricing in of a
fourth-quarter bounceback in corporate profits, with earnings
projected to climb 4.8% from a year earlier after declining nearly
2% in the third quarter, according to FactSet.
"We're in the late stages of an economic expansion. Things can
only go on for so long," said Mr. Adelman, who has been focusing on
investing in high-quality stocks that have relatively stable
earnings and offer hefty dividends that exceed U.S. Treasury
yields. "We have to be realistic. A lot of the positive news in the
market is already baked in."
Write to Michael Wursthorn at Michael.Wursthorn@wsj.com
(END) Dow Jones Newswires
July 29, 2019 05:44 ET (09:44 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.