An Earnings Roadblock for Stocks

By Anonymous
An Earnings Roadblock for Stocks

Investors are now well aware of both the effect the tax cut is having on companies’ bottom lines and the boost the humming economy is giving to their sales. Shown, the New York Stock Exchange on Sept. 12. Photo: bryan r. smith/Agence France-Presse/Getty Images

Companies’ third-quarter results should be very good. That doesn’t mean they will be good enough for investors.

Earnings season starts next week and, once again, the combination of a strong economy and corporate tax cuts should add up to some very strong growth. For companies in the S&P 500 analysts estimate third-quarter earnings at 21.6% above the year-earlier level, according to Thomson Reuters I/B/E/S. That isn’t quite so strong as the second-quarter’s 24.9%, but it still counts as one of the fastest expansions on record. (Analyst estimates often exclude charges and other special items).

The problem is that investors are now well aware of both the effect the tax cut is having on companies’ bottom lines and the boost the humming economy is giving to their sales. Look no further than the 7.2% gain in the S&P 500 since the start of the third quarter for evidence of that. As a result, companies’ capacity to positively surprise may have been diminished.

Meanwhile, there are some added risks to the downside. A tight jobs market is pushing labor costs higher as well as making it harder for many companies to find the workers they need to meet demand. The dollar was up 5% against other currencies in the third quarter from a year earlier, on a trade-weighted basis, marking its first gain in over a year. That will weigh on multinationals’ overseas sales when translated back into dollars. Tariff-related costs also may begin to bite more, and in their post-earnings calls, companies will be saying how new tariffs imposed on China last month will affect them in the future.

While none of these are likely to put a sizable dent in overall results, some companies could see disappointments at the margin. And in aggregate they may be enough to reduce the big earnings beats that investors have become accustomed to hear in recent quarters.

Indeed, there are some signs that companies may not clear the earnings bar that analysts have set for the third quarter quite so cleanly as in the second quarter, when a record number of companies beat analyst estimates.

When the third quarter started, analysts expected S&P 500 earnings would grow by 23.4%, so the 21.6% they now expect is a downward revision. That is not unusual, but the reverse happened in the second quarter when companies revised earnings figures a bit upward—an early indication of how big the second-quarter earnings beats would be.

Another difference: Far more companies are warning on earnings in comparison to those offering positive preannouncements. The third-quarter’s negative-to-positive ratio stands at 2.0; for the second quarter in early July it was 1.5.

Actual earnings growth should still surpass analyst estimates—it almost always does. The risk is that it will fall short of elevated expectations.

Write to Justin Lahart at [email protected]