Corporate profits will take center stage when fourth quarter earnings season kicks off next week.
The S&P 500 is set to post double-digit earnings growth for the fifth straight quarter, but earnings growth becomes more elusive this year in the face of slowing economic growth, elevated uncertainty and tough comparisons as the year-over-year tax benefit dissipates.
According to FactSet, fourth quarter earnings per share in the S&P 500 are expected to grow 10.6% year-over-year with revenue up 5.6%. Earnings grew 15.3% with revenue up 8.4% in the fourth quarter of 2017, so the bar is quite high. Third quarter earnings grew 26% (with revenue up 9.4%), the highest level since the third quarter of 2010, when the economy was still recovering from the Great Recession.
A slowdown in earnings growth was inevitable coming from such a high level, but expectations for the fourth quarter have come down markedly in recent months. Fourth quarter earnings were expected to grow 17% in mid-October, 14% in mid-November and just over 12% at the end of December. To be fair, earnings tend to come in modestly higher than Wall Street's projections heading into the reporting season.
S&P 500 earnings are expected to grow for the tenth straight quarter. Other than utilities, every sector is expected to grow earnings for the fifth consecutive quarter.
Strong economic growth and tax cuts continue to boost corporate profits. Fourth quarter earnings before interest expense and taxes (EBIT, or operating profit) are expected to grow a robust 11.2%.
- Fourth quarter earnings growth expectations by sector: Energy +75%, Industrials +14%, Communication Services +14%, Consumer Discretionary +11%, Health Care +11%, Financials +10%, Real Estate +9%, Materials +5%, Information Technology +3%, Consumer Staples +3%, Utilities -6%.
Excluding the Energy sector, which accounts for just 5.6% of the S&P 500's market value, fourth quarter earnings are expected to grow a still healthy 8.3%, with EBIT up 7.7%.
Fourth quarter expectations have come down as higher input costs, slower economic growth overseas and trade uncertainty became apparent. Despite Apple's (AAPL) high profile warning last week, negative preannouncements have not come at an alarming rate. Apple lowered guidance for the first time in the iPhone era, citing demand from China, but idiosyncratic factors are also at play as the company offers less value to consumers with its newest iPhones in the face of a saturated smartphone market.
For 2018 as a whole, earnings growth is expected to come in at 20% with revenue up 8.7%. Earnings before interest expense and tax are expected to grow an impressive 11.3%.
An outlook for slowing growth overseas and here in the US, tighter monetary policy from the Federal Reserve, political instability and trade uncertainty all weighed on equities in the back half of last year. At the same time, while the lower corporate tax rate should continue to spur more business investment, the year-over-year EPS tailwind goes away starting in the first quarter.
As a result, first quarter earnings per share growth is expected to slow to just 1.9% despite expectations for 6.2% revenue growth. Higher raw materials costs, wages and interest rates are pressuring margins. Meanwhile, uncertainty regarding tariffs on China seems to have pulled forward some demand into the fourth quarter. Estimates for the following quarter tend to come down during earnings season as companies set the bar to an appropriate level, leaving room for upside three months down the road.
Earnings are currently expected to grow a still healthy 6.6% in 2019 (with sales up 5.4%), but that is down from 10% growth in mid-October and 9% in mid-November. Estimates for double-digit earnings growth have often proven optimistic during this economic cycle. The last two years were the exception under the business-friendly Trump Administration. More recently, dysfunction in Washington DC creates an additional headwind as the Federal Government enters the fourth week of a partial government shutdown.
Uncertainty heading into 2019 brought valuations for the S&P 500 to multi-year lows in December as investors anticipated slower growth ten years into the cycle.
According to Capital IQ, the S&P 500 trades at 15.7x earnings estimates for the next twelve months and 15.0x 2019 earnings estimates. That represents a modest discount to the thirty-year average of just over 16x. Excluding the real estate sector (where earnings aren't necessarily the most relevant valuation metric), the Consumer Discretionary sector is the most expensive at 20.0x next twelve-month earnings estimates, followed by Consumer Staples at 17.3x and Communication Services at 16.9x. The Financial sector is by far the cheapest relative to earnings at 11.2x, followed by Industrials at 14.5x and Materials at 14.7x.
The U.S. Securities and Exchange Commission (SEC) allows companies a larger window to file their annual reports relative to quarterly updates. As a result, we will see preannouncements throughout January and fourth quarter earnings season will drag on into March. Next week, the big banks will dominant the corporate earnings newsflow.
Notable earnings out next week include:
- Monday: Citigroup (C)
- Tuesday: JPMorgan Chase (JPM), Wells Fargo (WFC), Delta Air Lines (DAL), United Health (UNH)... United Continental (UAL)
- Wednesday: Bank of America (BAC), BlackRock (BLK), Goldman Sachs (GS)... Alcoa (AA), CSX (CSX), Kinder Morgan (KMI)
- Thursday: Morgan Stanley (MS), PPG (PPG)... Netflix (NFLX), American Express (AXP)
- Friday: Schlumberger (SLB), V.F. Corp (VFC), State Street (STT)