By Michael Wursthorn
Investors counting on a corporate earnings rebound in the second
half of the year are risking disappointment.
Wall Street analysts have cut their third-quarter profit
estimates in recent weeks, painting a bleak picture for investors
already grappling with a simmering trade war, pockets of economic
weakness and ominous signs from the bond market.
Despite this week's partial reprieve from the Trump
administration, the latest round of tariffs on Chinese imports
compound the problems already facing many companies and threaten to
stifle their profit margins. Especially vulnerable are
manufacturers, miners and retailers.
At best, earnings across the companies in the S&P 500 will
grow 1.5% this year, FactSet projects, far short of estimates for
growth of more than 6% that analysts initially forecast in January.
Worse, a few analysts predict earnings could end up contracting for
2019 as a whole.
Dozens of companies, including Eastman Chemical Co., Macy's
Inc., Caterpillar Inc. and Cisco Systems Inc., have issued downbeat
outlooks, contributing to the pullback in profit expectations.
"Everyone in April and through the beginning of May thought that
the economy was going to get better in the back half of the year,
trade war was going to sort of settle, certainly not escalate,"
Eastman Chemical Chief Executive Mark Costa said on an earnings
call last month. "And now we're just in a very different world
where I don't think that's true...There's not a lot of signs of
economic recovery coming in the second half."
To be sure, surprises to the upside are fairly common with
earnings reports because analysts tend to be conservative with
their estimates. The first and second quarters were no different in
that regard. And other companies, such as retail giant Walmart
Inc., have offered more optimistic outlooks on the rest of the year
as they take market share from struggling competitors, bucking the
broader trend.
Still, analysts said investors shouldn't take the slowdown in
earnings growth lightly, especially as the outlook for later
quarters dims. Hanging over the stock market is a diverging U.S.
economy. Manufacturing activity in the U.S. has slowed for four
straight months. Service activity, which includes companies in the
health-care, finance and restaurant industries, has held up better
as Americans maintain a solid spending appetite and as employment
remains strong.
Although U.S. growth is slowing, it is holding up better than
other parts of the world. The latest economic figures out of China
showed its jobless rate in cities hit a record. Europe is also
stumbling as Germany said its economy shrank last quarter.
A healthy U.S. economy is important, but corporate profits are
the real engine behind stock market gains, said Yana Barton, a
portfolio manager at Eaton Vance. Stocks tend to meet less
resistance if earnings growth is robust, keeping valuation metrics
such as price/earnings ratios in check. Instead, P/E ratios drifted
last month as high as 17.5, which is considered somewhat expensive
as earnings growth flatlined, she said.
Without profit expansion, stocks could be more susceptible to
bouts of volatility, especially when investors have been grappling
with trade tensions for more than a year, along with signs that
economic growth in the U.S. is slowing.
"There are times we've been aggressively positive, but we
haven't been that way over the last year," said Ed Keon, chief
investment strategist at QMA LLC. The bleak earnings outlook and a
wide range of geopolitical issues contribute to his cautious view,
he said. In response, he said he has been hedging his exposure to
stocks by buying bonds.
The S&P 500 has slumped 4.5% in August, including
Wednesday's 2.9% drop and Thursday's 0.2% increase, leaving the
broad index roughly where it was a year ago. And moves in the bond
market have signaled that an economic slowdown could be on the
horizon.
Ms. Barton said stocks would have a catalyst to move higher if
the U.S. and China were to reach a trade deal or if economic data
improves. The S&P 500, for example, logged one of its best days
in months on Tuesday after the U.S. decided to delay some of the
tariffs it planned to impose next month.
But that decision doesn't fully alleviate concern or the cost
pressures that have already mounted on companies, analysts and
investors said.
Analysts' latest revisions show the S&P 500 faces a 3.2%
contraction in third-quarter earnings from a year earlier,
according to FactSet. And for the fourth quarter, the S&P 500
is now on track to increase profits by less than 4%, down from the
nearly 10% growth rate analysts expected at the beginning of the
year.
Cisco Systems, for one, provided revenue and earnings
expectations for the current quarter that were below analysts'
forecasts late Wednesday because of a decline in business from
service providers and China. Macy's also l owered its outlook for
the year Wednesday, pointing to a buildup in inventories. Tariffs
on some Chinese apparel imports are expected to strain the
department-store chain further. Shares of Cisco fell 8.6% on
Thursday, while Macy's declined 3.8%, extending its pullback this
week to 17%.
In some cases, companies are mitigating the costs of trade
tariffs and the paralyzing effect they are having on business
spending. But that isn't always reflected in share prices.
Scotch tape maker 3M Co. cut production and reduced inventory
because of waning industrial demand. Those moves helped it beat
second-quarter profit estimates, but shares are down 18% this
year.
Procter & Gamble Co., meanwhile, reported higher sales after
raising prices, bucking some of investors' concerns regarding
mounting costs. Shares have risen 28% this year and have slid only
half a percent this month.
Tariffs aren't the only factor to blame for the weaker outlooks.
Second-quarter profit margins across all S&P 500 sectors are
down from a year earlier, according to FactSet. Rising labor and
commodity costs, as well as a strong dollar, have helped to dent
profits.
Caterpillar, for example, cut its profit forecast last month,
blaming higher labor costs, as well as trade tariffs. Its shares
have fallen this year after notching steep declines this month.
"Caution is warranted as you look out to the end of the year,"
said Terry Sandven, chief equity strategist at U.S. Bank Wealth
Management. "There's still a reset in motion that will result in
earnings being lower than what's expected. It's one reason why we
think the market goes sideways from here."
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Write to Michael Wursthorn at Michael.Wursthorn@wsj.com
(END) Dow Jones Newswires
August 15, 2019 17:49 ET (21:49 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.
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