08 Jul C.J. Lawrence Weekly – Earnings Take Center Stage
Friday’s positive payroll report gave the stock market a bout of indigestion, complicating the argument that the Federal Reserve would commence an interest rate easing cycle at their July meeting. The market’s recent rise has been fueled by the prospect of lower interest rates, so the notion that rate cuts could be limited, upset the bullish narrative. Several Fed members have recently intimated that an “insurance” cut might be appropriate to help maintain a steady economic growth trajectory. But the market has been anticipating a more aggressive approach to combat trade related challenges and for the Fed to get in line with the longer end of the treasury yield curve. If the Fed follows the direction of the curve, at least two cuts would still be in the cards. The benchmark U.S. Treasury Bond Yield took note of the payroll report finishing up 5 basis points on the week but remains a half percentage point below where it was at the beginning of the 2nd quarter. Offsetting the payroll gains were the recent ISM Index reports which showed a continued deceleration in domestic economic activity. The ISM indices, which tend to lead corporate earnings estimate revisions, suggest that profit forecasts are headed lower.
According to FactSet, the magnitude of 2Q19 intra-quarter earnings estimate revisions was within the normal historical range, so recent adjustments received little fanfare. But the absolute results may catch investor attention as companies report 2Q19 results that come in below last year’s levels, and subsequently issue weaker forward guidance. FactSet bottoms-up forecasts currently call for 1.2% earnings decline in the quarter, and a sampling of early reporting companies suggests the result could be worse. Analysts are projecting that earnings will reaccelerate in the second half of 2019. But weaker forward guidance could push 3Q19 forecasts into negative year/year territory and question whether 2019 will even be a growth year for earnings.
Surprisingly, the S&P 500 Financial Services Sector Index is showing the greatest prospects for 2019 earnings growth and the second highest for the quarter. That forecast seems counter-intuitive in a declining interest rate environment. But, as a result of persistently low rates over the past decade, surviving financials have learned to grapple with a lower and flatter yield curve by cutting costs, reinforcing balance sheets and streamlining operations. At the other end of the spectrum, Materials and Energy sector constituent companies are expected to post negative results for both the quarter and the full year. At close to 18x 2019 earnings per share forecasts, and near 16.2x 2020 earnings per share forecasts, the market’s multiple expansion fuel looks to be running low. Finding groups and individual companies that can continue to grow earnings at good rates, as broader market earnings growth languishes, becomes the imperative for outperformance.