Drop in Q1 earnings growth
Final quarter earnings look so far so good with 62% of companies reporting positive earnings surprises, according to Factset but the fine cracks of this recovery can be seen when the spotlight is shone on the drop in Q1 earnings growth for the first month of the first quarter.
With more good surprises than bad ones coming for Q4 earnings, it is the drop in Q1 earnings growth that is the red-herring of a relatively okay earning quarter
So with stock prices forward-looking then a pressing question follows: How bad is the drop in Q1 earnings growth?
The forecast outlook on profitability for the first quarter of 2019 is overwhelmingly negative.
For Q1 2019, 33 S&P 500 companies have issued negative Earnings Per Share (EPS) guidance with only 9 S&P 500 companies have issued positive EPS guidance, according to Factset.
The Q1 bottom-up EPS estimate (which is an aggregation of the median EPS estimates for all the companies in the index) dropped by 4.1% (to $38.55 from $40.21) during January.
The drop in Q1 earnings growth for the first month of the first quarter is the largest decline in three years
The chart here, entitled Change in S&P Quarterly EPS: First Month of the Quarter illustrates the drop in Q1 earnings growth going back five years.
What is interesting to note is that earning this time last year in (Q1, 2018) shot up 4.9% and have been on a downward trajectory every other quarter since then. The worse earning decline over the period was in Q1, 2015 with an EPS -6.4% then Q1, 2016 with an EPS -5.5%.
The S&P earnings growth rate for Q1, 2019 is now forecast to decline by 0.8%. according to FactSet.
With a drop in Q1 earnings growth now a reality what sector has been hit the hardest?
Information technology has experienced a -8.9% decline in earnings. The energy sector has seen some wild swings from positive 16.5% earnings, 31 December to negative -5.9% today. Other sectors experiencing negative earnings are materials with negative -5.1% earnings, consumer discretionary negative -2.7%, consumer services negative -0.7% and financial with negative -0.1%.
Despite a drop in Q1 earnings growth with the S&P posting a negative -0.8% for Q1, 2019 there are a few sectors bucking the gloomy earning trend
Bread and butter style of investing could play out well for investors in 2019. Health care is experiencing Stella earnings with 7% gains today, then utilities with a gain of 5.2%. Industrials has also posted 4.2% gain, real estate also with 2.4% and consumer staples manage to stay in the positive with 0.3%. For a visual display of S&P 500 Earnings Growth: Q1 2019 see here courtesy of Factset.
The drop in Q1 earnings growth and its impact on sectors could give investors/traders insight into where the economy is heading in the economic cycle and other big macro trends
Late in the economic cycle, as the economy slows households tend to rein in their spending. Put simply, discretionary spending (money spent by consumers on non-essential purchases such as vacations and other luxury items) is less resilient than non-discretionary spending in an economic downturn. So the fact that we see companies offering non-discretionary goods and services (essentials) posting positive earnings could be evidence of recessionary pressures building in the economy.
However, industrials upbeat 4.2% earnings picks holes in the view that the US economy is heading for a recession. But that could be explained due to a policy shift from the US Trump administration which views global trade as a zero-sum game. The latest industrial earnings confirm that the US is re-industrializing, rebuilding its manufacturing also behind a wall of protectionism.
As China’s manufacturing heads into a steep decline which is being accelerated by $250 billion in China tariffs US manufacturing earnings is gaining momentum. Moreover, US manufacturing sentiment reached its highest in three months with output increasing faster and domestic demand driving new business growth. Already 9 out of 12 industrials have reported double-digit growth.
US industrials are bucking the trend of a drop in Q1 earnings growth despite the US-China trade war
In fact, if the latest industrial data from Factset and the US PMI is anything to go by then the US could indeed win a trade war with China and come out the other end more prosperous. The facts are disturbing to those who argue that global trade is not a zero-sum game.
But what about looking beyond a drop in Q1 earnings growth, which is now expected to be the first quarter since 2016 to post a negative -0.8% earnings growth on revenue of 5.7%?
For Q2 2019, analysts are projecting earnings growth of 1.6% and revenue growth of 5.1%.
For Q3 2019, analysts are projecting earnings growth of 2.7% and revenue growth of 4.9%.
For Q4 2019, analysts are projecting earnings growth of 9.9% and revenue growth of 6.0%.
For CY 2019, analysts are projecting earnings growth of 5.6% and revenue growth of 5.3%
In short,2019 earnings for the full year is a 30% haircut to the 7.8% growth that was expected on December 31.
What impact could a drop in Q1 earnings growth have on overall stock prices?
If the old norm is the new norm where declining earnings means rising prices then maybe traders and investors should not panic. Fed capitulations on monetary tightening mean bad news is good news again for stocks because it implies QE to the rescue and a central bank inspired bull market is intact. For the best chart see here which shows earnings tanking and stock prices rising